A guarantee is a binding agreement that involves the lender, the borrower and the guarantor. A guarantor promises the lender that they will pay the loan if the borrower fails to do so.
However, several circumstances make a guarantee unenforceable by the lender (i.e. the guarantor can avoid the guarantee and not repay the debt to the lender) (see “Rights of a guarantor“˜Other ways a person can escape liability under the guarantee and “Guarantee limitations in “The NCC and guarantees’ section, below). Also, a guarantor can cancel their guarantee at certain points in the lending process and in certain circumstances (see “The NCC and guarantees’, below).
Note that for credit contracts regulated by the National Credit Code, there are additional requirements for guarantees (see “Formalities of guarantees’ in “The NCC and guarantees’ section, below).
The following applies to all guarantees, whether or not they are regulated by the NCC. The provisions of the Code of Banking Practice regarding guarantees may also apply. For more information about the codes of conduct for the credit services industry, see Unauthorised transactions and ePayments Code.
A guarantee is a binding agreement that involves three parties: the credit provider (lender); the debtor (borrower); and the guarantor. Guarantees are sometimes required by credit providers before they agree to lend money if they suspect the debtor may not be able to make all repayments.
A “guarantor” promises the credit provider to repay the loan if the debtor refuses or fails to repay the loan. Agreeing to become a guarantor may cause financial hardship. It involves more than helping out a friend or relative who needs money or wants to buy goods on credit, because if the debtor stops making repayments the guarantor has to pay.
A guarantee involves a promise by the guarantor that they will pay the debt owing to the credit provider if the debtor fails to pay it.
Unless the guarantee document is a deed, the guarantee must be given before or at the time the credit provider lends to the debtor. If the guarantee is given after the credit provider lends to the debtor, the guarantee may not have been given in exchange for the loan; this makes the guarantee unenforceable.
Also, if the credit provider used any force, fraud, illegality, duress, undue influence, or allowed the guarantor to be mistaken about their rights and liabilities under the guarantee, the guarantee may be avoided. A guarantee may also be avoided if the credit provider was aware of another party using fraud, illegality, duress, undue influence or mistake against a potential guarantor.
The guarantor is entitled to recover any money paid from the debtor, if possible. Also, the guarantor is entitled to any securities held by the credit provider. In Lavin v Toppi  HCA 4 at 52, it was held that a co-guarantor to a bank loan (Lavin) – who subsequently entered into a deed of release with the bank that contained a promise by the bank not to sue Lavin – had to make an equitable contribution to her co-guarantor who paid a disproportionate amount of the guaranteed debt to the bank.
A guarantor may be freed from their obligations if:
• the guarantee is altered by the credit provider (e.g. the name of one co-guarantor is struck out);
• the credit provider changes;
• the guarantor is called on to pay but the credit provider cannot hand over securities it has taken;
• the credit provider fails to protect the guarantor (e.g. fails to insure when there is an obligation to do so); or
• the credit provider alters the guaranteed contract (e.g. by giving the debtor more time to pay than the original contract provides for), as long as this alteration is by a binding contract.
However, the terms of the guarantee may be framed so as to make the guarantor still liable even if one of the matters listed above has occurred.
The most recent version of the Code of Banking Practice (“Banking Code”), which has applied since 1 January 2014, contains additional protections for people who are or may become guarantors.
In National Australia Bank Ltd v Rose  VSCA 169, the Victorian Court of Appeal confirmed that NAB had breached the Banking Code by failing to verbally inform a guarantor, Mr Rose, of certain written warnings in the documents (including that the guarantor should seek independent legal advice before signing), in the course of taking five guarantees from him in connection with the purchase of investment properties. The court held that the Banking Code was a term of the guarantee, and so the Banking Code breach constituted a breach of the banker–client contract. The court concluded that NAB’s breaches of the Banking Code caused loss to Mr Rose in the amount of the guarantees. This had the effect that Mr Rose was entitled to set-off damages (i.e. that his liability under the guarantees should be reduced by the amount of his loss).
In Doggett v Commonwealth Bank of Australia  VSCA 351, the Victorian Court of Appeal confirmed that clause 25.1 of the Banking Code was a term of guarantees given by two guarantors, and accordingly required the bank to exercise the care and skill of a diligent and prudent banker in assessing whether a borrower would be able to afford and repay a loan. In this case, however, the guarantors were not entitled to a remedy because they had released the bank under a compromise agreement.
In Commonwealth Bank of Australia v Wood  VSC 264, the guarantor alleged that the CBA breached the Banking Code by giving the guarantee to the debtor, or someone acting on behalf of the debtor, to arrange the signing. The guarantor also argued that the bank failed to ensure that he signed the guarantee when the debtor was not there, and that the breaches gave him the right to terminate the guarantee. The court found that the guarantor had failed to prove that his loss, which was the amount of his liability under the guarantee, was caused by the breach of the Banking Code. So even through the court found that the relevant provisions of the Banking Code were incorporated as contractual terms of the guarantee, and that they were breached, the guarantor was not entitled to a remedy.
(See “Code of Banking Practice” in Unauthorised transactions and ePayments Code.)
Formalities of guarantees
The NCC creates additional requirements for guarantees that are entered into in relation to a credit contract regulated by the NCC.
A guarantee must be in writing and signed by the guarantor, although it will be enough if the guarantee is contained in a mortgage signed by the guarantor (s 55 NCC). The guarantee will not be enforceable unless these requirements are complied with (s 55(3)).
A copy of the credit contract must be given to the guarantor before they sign (s 56(1)(a)). The guarantee is not enforceable unless this is done (s 56(2)).
The credit provider must also give the prospective guarantor a copy of a booklet entitled “Things you should know about guarantees”, which explains the rights and obligations of the guarantor (s 56(1)(b); reg 82 National Consumer Credit Protection Regulations 2010 (Cth) (“NCCP Regulations”)).
The credit provider must, within 14 days after the guarantee is signed, give the guarantor a copy of the guarantee signed by the guarantor and any related credit contract or proposed credit contract (if a copy of the related contract has not previously been given to the guarantor) (s 57).
A guarantor can withdraw from a guarantee by giving written notice to the credit provider:
• at any time before credit is first provided under the credit contract; or
• after credit is first provided under the credit contract, if the contract is materially different from the proposed credit contract given to the guarantor before they signed the guarantee (s 58 NCC).
A guarantee can also be cancelled by a court under section 76 of the NCC if it is found to be unjust (see “Unjust contracts”).
A guarantee may provide that the guarantor guarantees not only the debtor’s obligations under a particular credit contract but also obligations under future credit contracts (s 59(1) NCC). The guarantee will only be enforceable in relation to future credit contracts if the credit provider has given the guarantor a copy of the contract document of that future credit contract and subsequently obtained from the guarantor a written acceptance of the extension of the guarantee (s 59(2)).
A guarantor’s obligations under a guarantee can be significantly increased in a variety of ways (s 61 NCC). For instance, the credit contract subject to the guarantee may allow the debtor and credit provider to agree to vary the contract by providing further amounts of credit under that contract to the debtor. However, the increased liability has no effect unless:
• the credit provider gives to the guarantor a written notice setting out how the terms of the credit contract will be changed to allow the increase in the guarantor’s liabilities; and
• the credit provider subsequently obtains from the guarantor an acceptance of the extension of the guarantee to that increased liability (s 61(2)).
Certain exceptions to these requirements are set out in section 61(2) of the NCC.
In ANZ v Manasseh  WASCA 41, the court had to decide if a second letter of offer to a borrower (to increase the borrower’s loan facility limit) was a new or replacement arrangement, or a variation of the original loan agreement entered into by the borrower. The guarantor had given a guarantee to the bank in respect of the borrower’s original loan. The terms of the guarantee provided that the guarantor would not be liable for any new or replacement arrangements unless he consented to them. The guarantor refused to consent to guarantee payment of the second loan offer. The bank allowed the borrower to draw funds under the second offer without obtaining the guarantor’s consent. The question arose if the guarantor was liable to pay the bank the borrower’s increased debt under the second loan offer. The Court of Appeal decided that the second loan offer was a new agreement, which caused the termination and replacement of the original loan agreement. This meant that the guarantor was not liable to pay the borrower’s debt. Lenders must obtain the existing guarantor’s consent or enter into new guarantees when a borrower’s facility agreement is replaced.
If a guarantor gave a guarantee (including a clause giving a legal mortgage) to a credit provider to secure a debtor’s debt, and the guarantor bankrupts after the credit provider called on the guarantee to be honoured, the bankruptcy makes no difference to the enforceability of the guarantee (see GE Commercial Co (Aust) Pty Ltd v Nicholas as Trustee of Bankrupt Estate of Lymn  NSWSC 562 (13 April 2012)).
A guarantee will be void to the extent that it:
• secures an amount that exceeds the debtor’s liabilities under the credit contract and the reasonable expenses to enforce the guarantee (s 60(1) NCC); or
• limits the guarantor’s rights to indemnity from the debtor (s 60(5)).