BY Michael Papas
Sureties and guarantors: A gap in the law of guarantees
In many ways, sureties and guarantors live in similar legal worlds as both secure the obligations of a principal debtor to a third-party collector, where both rely on that debtor’s default to trigger the collateral provider’s payment obligation to the creditor. But does this mean that they both imply a right of recourse against the principal debtor? The answer to this question has significant implications for financial institutions.
A Western Cape High Court Judge considered this question recently in what may turn out to be a landmark case in the law of guarantee. And until the matter is finalised, it remains to speculate on this unexpected gap in South African law and why it came to be.
First, some context. It is trite law that a surety who secures the obligations of a principal debtor to the latter’s creditor has if the surety is obliged to pay the creditor, a right of recourse for his or her loss against the debtor. This right arises from one of two underlying legal mechanisms: mandate or negotiorum gestio. In the case of mandate, the debtor has knowingly mandated the surety to pay the creditor in a given scenario, thereby promising to make good the surety’s payment should that scenario arise. In the case of negotiorum gestio, the surety acts in good faith, albeit without the debtor's knowledge or consent, by paying their debt to the creditor, and for that, the surety is entitled to compensation.
But the question arises: Does a guarantor who pays the debt of a principal debtor to the latter’s creditor also enjoy this right of recourse? Surprisingly, existing law offers no answer.
Until some decades ago, South African law did not distinguish between suretyship and guarantee. A passage from a judgment of the Appellate Division back in 1939 said: “The word (guarantee) is usually and more properly employed by a surety who promises to saddle himself with an obligation if the principal obligor defaults.” [Our emphasis]
But in recent times, the concepts dovetailed, with a surety’s obligation becoming accessory to the principal debtor’s duty while the guarantor took on an independent, primary obligation to the creditor. The surety promises the creditor that the debtor will pay, and should they not do so, they will step into the debtor’s shoes and pay the creditor directly. On the other hand, the guarantor simply promises to pay an amount of money in a particular scenario, which may just be the debtor’s payment default.
The question arises: why should this distinction mean that a surety can claim back their payment from the debtor while the guarantor is not able to? The underlying mechanisms justifying the recourse – mandate or negotiorum gestio – don’t obviously lend themselves to a suretyship nor a guarantee. Why should a surety have the right to claim back the money from the debtor but not a guarantor?
One argument is that there's no legal basis for a guarantor to claim such a right. Perhaps the guarantor takes on their own obligation, which has nothing to do with the debtor except rely on the latter’s non-payment as a trigger event. In this case, why should the guarantor be able to turn to the debtor for compensation for the guarantor’s payment of their own independent obligation?
The resolution to this issue isn’t apparent, but the implications are significant. What will it mean for financial institutions that regularly guarantee the obligations of others if they can’t rely on a right of recourse against the principal debtor in the event of default? We look forward to finding out how this story ends.
Reviewed by Manchadi Kekana, an Executive in ENS' Insolvency practice.
Associate | Insolvency