The use of a guarantee in property transactions becomes more common during times of economic downturn, as a party to a transaction seeks greater security from the other party. A vendor might be apprehensive about the other party’s ability to complete their obligations under an agreement, or concerned about the assets of that party and the ability to recover losses if there is a default event.
This article examines what a guarantee is, the obligations it places on a guarantor and the common uses of guarantees in property transactions.
What is a guarantee?
A guarantee is a form of contract between two persons, which is intended by them to secure the performance of an obligation of a third party to one of them. The essential features of a guarantee are:
- The existence of a present or future obligation of a third party; and
- An intention of the parties to the contract for the third party to secure the performance of that obligation.
In practical terms, it can be described as follows:
- Party A (Guaranteed Party) and Party B (Principal) enter into an agreement.
- To ensure Party B completes their obligation under the agreement, Party A requests Party C (Guarantor) to guarantee the obligations of Party B.
- Party B does not meet its obligation. Party A relies on the guarantee from Party C and forces Party C into completing Party B’s obligation.
The obligation of a Guarantor
Guarantees are an effective tool for Lenders, Landlords or Sellers, to protect their interest under their respective agreement. In the event the principal fails to meet its obligations under the agreement, the Guarantor will be required to step into the role of the principal and fulfil the obligation. Some provisions included in a guarantee may entitle the guaranteed party to call on the guarantee regardless of whether the principal has been given notice of their breach and afforded an opportunity to rectify. Where there are multiple guarantors, the principal may be entitled to elect to enforce the guarantee against all of the guarantors or against them individually.
Therefore, it is vital that before entering into a guarantee in a property transaction, you understand the terms of the guarantee, the obligations of the guarantor and when you can enforce the terms of the guarantee against the guarantor.
Guarantees in property
There are three common types of property transactions that may involve a guarantee. These are leases, property purchases and loans/mortgagees.
It is commonplace for Landlords to require Tenants that are companies to provide personal guarantees from the directors of the tenant company. If the Tenant is in default under the Lease obligations, then the Landlord may pursue the Guarantor/s to rectify the default of the Tenant. A default that may result in the Landlord taking action against the Guarantor is the Tenant’s failure to pay rent, their failure to comply with their make good obligations at the determination or expiry of the Lease, or the failure to rectify any damage caused to the premises during the term of the Lease.
Similarly, where a company is the purchasing entity for a property to be sold, a Seller may request that directors of the company provide a guarantee. The purpose of the guarantee in this instance is to ensure that the Buyer’s obligations are met and if the buying entity fails to settle, fails to pay any monies when they are due and payable, or fails to comply with any other terms of the Contract, the Seller can take action against the Guarantor. The Guarantor may be required to pay damages or to step into the shoes of the buying entity and complete the Contract.
Another type of guarantor that is common, is the requirement of a guarantee to be provided to a bank or financier when purchasing property. Examples include directors of a company providing a personal guarantee for the company as lender, or parents providing a personal guarantee on behalf of their child when buying their first home. In this instance, the guarantor is guaranteeing the performance of the borrower under the loan documents. If the borrower fails to pay back the loan on time or does not comply with the terms of the mortgage, the Guarantor can become liable to remedy the default.
Other types of security and how Redchip Lawyers can help
There are other forms of security that can be provided in place of or in addition to a guarantee to provide protection to the secured party. These include a mortgage over real property, security over personal property (which can be registered on the PPSR), or a Bank Guarantee or Cash Bond.
Different forms of security have different risks and benefits. Redchip Lawyers can assist you in determining the right type of security to protect your interests in a transaction and in preparing the necessary documentation.
If you would like to discuss this article in further detail, please reach out to our property team on 3223 6100.