Lenders provide loans with the paramount aim of being paid back. Towards this end, lenders sometimes require borrowers to provide guarantors as additional security for repayment. The issuance of a guarantee usually provides comfort to the lender that in the event of default, it can either go after the principal borrower or the guarantor.
A guarantee refers to a pledge by a person (guarantor), other than a party upon whom the contractual or other legal obligation is imposed, to the effect that if the party so bound (principal) fails to perform the act in question, the guarantor will either perform or make good any loss or claim arising from the principal's non-performance.
The guaranteed relationship is usually created through a letter of guarantee (Guarantee). The Guarantee would state its nature and scope, and the obligation of the guarantor. A guarantor is therefore only liable to the extent of the scope set out in the Guarantee.
In the case of Ebony Development Company Ltd vs. Standard Chartered Bank Ltd, the court stated that the guarantor becomes liable upon the default of the principal debtor.
Further, courts have held that the obligation of the guarantor arises immediately the default occurs without being entitled to require either notice of default or previous recourse against the principal.
The issue of whether the creditor should first pursue the principal debtor has been well litigated. For instance, in Ecobank Kenya Ltd vs. Francis Tole Mwakidedi, the court stated that a creditor is free to choose which debtor to pursue. In short, a creditor can choose to pursue a guarantor prior to pursuing the principal debtor.
Some guarantors have argued that it is unfair for the creditor to pursue them before going for the principal debtor since theirs is a secondary security. The debate even found itself in Parliament in 2019 when a bill was introduced to amend the Law of Contract Act Cap 23. The amendment sought to obligate creditors to first realise the security of the principal debtor before pursuing the guarantor. The argument by proponents was that it would protect guarantors. The bill was, however, rejected by the President for several reasons, including, that the effect of the amendment would be to prolong the process of settling debts in case of default without the assurance that the outcome will be positive.
Had the bill been assented to, it would have interfered with the sole obligation of a guarantor which is to pay the debt upon the default of the principal debtor without the condition that the creditor first exhaust recovery means against the principal debtor.
The recent High Court ruling in Home Afrika Limited v Ecobank Kenya Limited (Home Afrika decision) setting aside a statutory demand that Ecobank had issued to Home Afrika sparked some debate on what exactly the role of guarantees is and how they relate to the other securities that a lender may hold.
In setting aside a statutory demand that had been issued by Ecobank as the creditor to Home Afrika as the guarantor, the court stated that the creditor could not go after the guarantor since it had already obtained leave of the court to purchase the property offered as security by the principal debtor even though the creditor demonstrated to the court that it could not sell the property despite several attempts at a sale by public auction.
Value of security
The impact of the decision is that if a creditor holds some security in respect of a debt claimed by a statutory demand and the Court is satisfied that the value of the security equals or exceeds the full amount of the debt, then such creditor cannot go after a guarantor and any statutory demand issued by such a creditor will be set aside by the court.
Furthermore, a creditor is precluded from pursuing enforcement action against a guarantor if the creditor had purchased the secured property pursuant to the leave of the court.
Before issuing statutory demands to guarantors, lenders therefore need to check whether they hold any security in connection with the debt owed and whether the value of such security equals or exceeds the full amount of the debt.
The security documents also need to clearly provide that the principal debtor and guarantor bear equal liability for repayment of the debt.
Amrit is consultant in the Real Estate and Finance Practice Group at DLA Piper Africa, IKM Advocates while Bonface is a Senior Associate and Amollo is an associate in the same practice