In layman’s terms, a credit agreement is an undertaking by a lender to advance to a person or an entity a specific amount of money for, usually, a specified period of time, and an undertaking by the borrower to return the amount of money to the lender as agreed. However, the risk of uncertainty as to whether the monies will be returned always exists. Such uncertainty gives rise to mechanisms that creditors may use to ensure that, if the borrower cannot repay the debt, they have another recourse to recover the amount owing.
In order to mitigate the risk of unpaid debts and the non-fulfilment of obligations contained in the credit agreement, creditors rely on the laws and principles relating to security. Creditors may require security for the honouring of obligations, particularly debt repayments, by a debtor by concluding a suretyship agreement or guarantee agreement. Both these agreements assure recourse from a third party for payment of the outstanding debt owed by the borrower.
In credit agreements where the creditor includes an assurance that the loan will be repaid, there are three role players: the creditor, the principal debtor and the surety/guarantor/co-principal debtor. This last party differs depending on the type of agreement entered into (that is, a credit agreement containing a suretyship agreement, or a credit agreement containing a guarantee agreement). Although these agreements are similar in operation, they differ in their respective legal implications and consequences.
Forsyth and Pretorius define a suretyship agreement as
“an accessory contract by which a person (the surety) undertakes to the creditor of another (the principal debtor), primarily that the principal debtor, who remains bound, will perform his obligation to the creditor and, secondarily, that if and so far as the principal debtor fails to do so, the surety will perform it or, failing that, indemnify the creditor.”
So, the surety binds himself on behalf of the principal debtor and undertakes to step into the shoes of the principal debtor to pay back the creditor, should the principal debtor not do so. While this is the definition of the common-law surety undertaking, legislation requires that such a contract be in writing and signed by the surety (s 6 General Laws Amendment Act 50 of 1956).
However, the principal debtor is not automatically exempt from paying back the monies should he be unable to do so, merely because a surety exists. The principal debtor and the surety become jointly and severally liable, meaning that the creditor may take the necessary legal steps to recover the monies from the principal debtor and the surety. Usually, a creditor need not seek to recover an outstanding debt from the principal debtor before recovering the monies from the surety, because most such agreements include a waiver of the right to excussion and division by the surety. Suretyship agreements are often included in business loan agreements and student loan agreements.
An example of a credit transaction where a suretyship agreement is an accessory to the initial agreement would be in the event where Dextoria (Pty) Ltd loans a million Rand from Creditorius Financial Institution to be repaid in instalments over 72 months. Mr. Amos, the director of Dextoria (Pty) Ltd, signs a written suretyship agreement undertaking to fulfil Dextoria (Pty) Ltd’s financial obligations should it fail to do so. Mr. Amos also undertakes to allow Creditorius Financial Institution to recover the monies from him without requiring it to recover the monies from Dextoria (Pty) Ltd first.
Because a suretyship is ancillary to and dependent on the principal credit agreement, it follows that, if the credit agreement is invalid, the suretyship agreement falls away since it is an accessory liability (see Shabangu v Land and Agricultural Development Bank 2020 (1) SA 305 (CC)). There is a burden on the creditor to properly explain the implications of a suretyship agreement to the debtor and also for the debtor to understand and acknowledge the liability and obligations they place on themselves (See Davids & Andere v Absa Bank 2005 (3) SA 361 (C)).
In contrast with a suretyship agreement, a guarantee agreement is not ancillary to the initial credit agreement. Should the credit agreement be proved invalid, the creditor may still require the guarantor to pay the amount owed, based solely on the guarantee agreement. Therefore, while in suretyship agreements the surety has a secondary obligation to the creditor for payment of the amount owing, in guarantee agreements there is a primary obligation on the guarantor equal to that of the debtor and the creditor may enforce the guarantee agreement as an independent agreement. The creditor may require the guarantor to fulfil its obligation because this is not conditional on a breach of contract, an invalid contract or default by the debtor. The enforcement is merely conditional on a certain event taking place.
For example, if Mr. Amos opted to enter into a guarantee agreement, which, unlike the suretyship agreement, does not have to be in writing, and the credit agreement entered into between Dextoria (Pty) Ltd and Creditorius Financial Institution is declared invalid, causing the financial institution grave loss, Mr. Amos’ obligations remain fully in force as if the guarantee agreement is the initial agreement. In essence, the guarantor promises to pay and perform in full when an event occurs but does not promise that such an event will ultimately happen.
It is important to note that a guarantee agreement is a continuing covering security that, during its duration - before official written termination - remains of full force and effect, notwithstanding any temporary variations or extinction of debts or prior payments under the initial agreement. The guarantee agreement is only discharged upon full payment of the debt and/or performance of the principal obligation by the guarantor in compliance with the terms of the agreement.
Therefore, to answer the initial question of whether suretyship agreements guarantee that creditors will get their money back, it should be noted that suretyship agreements and guarantee agreements are two similar but different instruments with different obligations on the parties and possessing different legal and economic implications So, while both agreements provide a creditor with some form of security, all signatories of either such agreement should be cognisant of the risks allocated to each form of agreement when concluding a credit transaction.
