31 Dec Top tips to avoid surety traps
Top tips to avoid surety traps
Most business owners are familiar with the principle of caveat emptor, or ‘buyer beware’. However, many unwitting individuals are entering into surety agreements or acting as guarantors, without fully understanding the implications and risks.
“Some local banks are beginning to take a more relaxed approach to surety, sometimes only asking you to sign for surety for 50 percent of the loan. However, this leeway is still largely only extended to high net worth individuals able to provide ample security. Signing surety for 100 percent of the debt sets South Africa apart and is not required in the UK, US or Australia – possibly because in South Africa local banks are backing the individual, not the transaction,” explains Gary Palmer, CEO of Paragon Lending Solutions.
Leah Darley, Partner: Commercial at Bernadt Vukic Potash and Getz Attorneys, explains the difference between independent guarantees and suretyships:
“Guarantees are primary obligations and not accessory in nature as is the case with suretyships. This means that, for example, in the event of a payment default, the lender can (after complying with the conditions of the guarantee), immediately and directly approach the guarantor and claim payment under the guarantee. In the case of a party signing a suretyship, the liability of the surety depends on the validity of the underlying contract (any disputes in this regard must be resolved first) and generally the lender is required to first try and reclaim defaulted funds from the debtor, before they approach the surety”.
Independent guarantees thus give banks and other lending institutions a direct line to recoup their loans, rather than going through the much lengthier process of pursuing the debtor first – who is clearly already in financial trouble. Moreover, the defences that can be raised to a claim under a guarantee are quite limited, for example fraud. This logically puts a lender in a much stronger position.
Palmer says lenders will, understandably, do whatever they can to protect their loans and believes it’s vital that any person entering into either a guarantee or suretyship examine the contract closely. Advice for when signing surety includes:
- Sign for a specific debt only – clearly state the purpose of the loan. Many people have been caught out by signing surety for a specific business venture, only to find out that the business owner has gone on to make additional loans for other ventures and they are on the hook for these too.
- Limit the amount for which you are liable – Never sign a contract which does not clearly stipulate the amount of principal debt being covered. Should the borrower approach the lending institution (sometimes years) down the line asking for advances on the original loan, the person signing surety will be liable for the additions as well as the original amount. Unless there is a written exclusion, it is assumed that suretyship will include continuing cover security.
- Beware of putting up securities to cover the surety – some lenders may doubt the ability of the surety to honour the debt and they may ask that they put up assets as security. This can result in them losing a home or other collateral if the borrower defaults.
- Protect yourself against other sureties – If there are multiple sureties in a contract, signatories must closely examine the contract to ensure that, should the borrower default, all the signatories will stand jointly liable for recovery. A joint and several clause is par for the course in contracts and gives the lender the ability to pick the co-surety signatory most able to pay the outstanding loan and pursue them in isolation. Even though there is recourse for the co-signatory to try recover some of the payments from the other co-sureties, it’s both an expensive and lengthy process.
- Beware of common law defences which might be renounced in the suretyship – these defences protect a surety. An example is the benefit of beneficiam excussionis, in other words the defence that the lender must first obtain payment of as much of the principal debt as possible from the principal debtor.
Despite the pitfalls, there is no doubt that in some cases surety can be beneficial. If a person can’t get a loan based on their personal balance sheet, but has a high net worth person willing to stand behind the deal, then the deal may work. An example of this would be a business owner trying to increase the bond on his house to invest in his business, but the deal is too big for his balance sheet, so a high net-worth individual backer signs the surety and the deal goes through.
“When looking for deal finance, lenders will insist on securing their loan. Working with an independent lending partner who will structure the deal with you, means you can rely on expert advice that protects your business and your most precious asset – your close network of supporters who are willing to financially back you and sign security,” concludes Palmer.
About the author
Gary Palmer is the CEO at Paragon Lending Solutions, which he founded in 2009 and has grown into a successful provider of finance to established entrepreneurs. A Chartered Accountant with more than 18 years’ experience, Gary has a comprehensive understanding of the financial levers for business growth. During tenures at Ernst Young UK and Investec SA, he specialised in corporate finance, focusing on financial structuring for institutional high-net-worth individuals. In 2007, he established a finance business that became Paragon. Today, Paragon helps clients get the right financial structures in place in the quickest and most effective way to optimise their financial affairs for wealth creation.
Paragon Lending Solutions is an independent lender, supported by one of the big four local banks. It helps established entrepreneurs grow their assets by structuring and accessing the right financing. Clients often lack the understanding, experience and knowledge of funding structures and product options that are available for the best, quickest and most effective path to growth. Paragon uses its diverse portfolio of lending products, extensive network of funding partners, and own balance sheet to address its clients’ need for property or bridge financing and working capital. Founded in 2009, it has financed deals in excess of R1.5 billion for a diverse portfolio of clients with varied financial requirements.