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On-demand guarantee or suretyship? Beware the loophole

16 Aug 2016

It is South African market practice in the context of financing transactions, that when a party is required to provide a guarantee in respect of another party's (the Debtor) obligations to a creditor (the Creditor), that such guarantee is treated like a call or on-demand guarantee. Until now, not much thought has been given as to whether such a guarantee can be treated as anything other than just that - an on-demand guarantee.

On-demand guarantee or suretyship? Beware the loophole

Typically, an on-demand guarantee will include wording such as “this is an unconditional and irrevocable guarantee” and “the guarantor hereby undertakes (as a principal obligation enforceable against the guarantor) to pay”.

A recent Supreme Court of Appeal judgment, however, has caused some confusion in this regard.

In this judgment, a purported on-demand guarantee was found to be inextricably linked to the performance by the Debtor in respect of the underlying contract and therefore to be akin to a suretyship, as opposed to an on-demand guarantee.

In reaching this conclusion, the court referred back to the parties’ intention in respect of the guarantee and in doing so, found that the guarantee could not be considered an autonomous guarantee or obligation, but rather that it was inextricably linked to the underlying contract and the performance required by the Debtor in respect of that underlying contract.

In order to avoid this conclusion in respect of guarantees, which are intended by the guarantor and beneficiary of the guarantee to be on-demand guarantees and not suretyships, it is important for South African law purposes that that guarantee expressly states that the parties intend that guarantee to be a principal obligation and not merely an ancillary obligation.

Essentially, the guarantee should state that the guarantor “hereby (as principal obligor and not merely a surety), irrevocably, unconditionally and on the basis of a several and discreet obligation enforceable against the guarantor, whether or not any or all of the guaranteed obligations are enforceable against the Debtor” avoids any kinship to a suretyship.