Key Terms defined according to section 68 of the Contracts Act, 2010;
Contract of guarantee; - means a contract to perform a promise or to discharge the liability of a third party in case of default of that party, which may be oral or written.
Guarantor; - means a person who gives a guarantee.
What happens to the guarantor if the debtor fails to pay the loan to the creditor or dies?
Section 71 of the Contracts Act, 2010 is to the effect that
“The liability of a guarantor shall be to the extent to which a principal debtor is liable unless otherwise provided by a contract and the liability of a guarantor takes effect upon default by the principal debtor.”
This means that if the principal debtor fails to pay off the debt, the liability burden shall be on the guarantor unless the terms of the contract protected him/her in case of failure to pay the debt.
A case in point is Alice Norah Mukasa vs. Centenary Bank Limited and Bonny Nuwagaba Civil Suit No.77 of 2010. Where court held that;
“The purpose of a guarantor to a loan is to render assurance to the lender that in the event the borrower dies or fails to pay back the loan sums, the guarantor would pay back the money. This is why the mortgage agreement makes the debtor and the guarantor jointly and severally liable.”
Whereas discharge of a guarantor in the Law of Banking,
According to Anu Arora in his book Banking Law[1] he observes that the courts have generally been protective of the guarantor so that any ambiguity in the contract of guarantee or any onerous or unfair terms will be construed against the bank.
The courts have held in the case of Barclays Bank Plc v Khaira[2] that a bank is not under any duty to offer advice to a prospective guarantor about the merit of giving the requested guarantee. This means that bank managers are warned against giving investment advice, which might be relied upon by their customers.
Apart from other considerations, this would result in direct conflicts of interest since it is the bank that will be the beneficiary of the guarantee arrangement. Thus, while the bank will make its own decisions about whether or not to enter into a guarantee arrangement any investigations and inquiries will be for its own benefit. Credit approval for a particular facility will not, therefore, imply any positive advice or recommendation to the prospective guarantor.
This leads us into the case summary; - Citibank Uganda Limited V Uganda Fish Packers Ltd, Alpha Group Ltd, Masese Fish Packers Ltd, Fiaz Shokatali Kurji, Karim Shamsodin Kurji, and Arzina Kurji) HCT – OO- CC-CS-254-2009 that was before Honorable Justice David Wangutusi
The Facts to the case;
The Plaintiff extended credit facilities to the 1st Defendant comprised of a term loan, an overdraft, post-shipment, and pre-shipment which were executed in facility letters and guaranteed by the 2nd and 7th Defendant. One of the terms was that in the event the opinion of the plaintiff might have a material adverse effect on the 1st Defendant’s business or their ability to comply with any of their obligations, then that would amount to an event of default entitling the Plaintiff to terminate the facilities and demand full payment.
In May 2009, the Managing Director of the 1st Defendant died and there was a struggle to meet their repayment obligations. The Plaintiff perceived the death of the Managing Direct to constitute a “material adverse effect” event for which the facilities were terminated. The Plaintiff issued a formal demand for the 1st Defendant to repay the outstanding amounts on the facilities and also to the 2nd – 7th Defendant to repay the outstanding guaranteed amounts.
The defendants failed to honor the formal demands therefore, the plaintiff brought the suit in which they seek recovery of US$ 3,706,895.00, Ugx 7,003,733,847, and interest on the amounts until payment in full.
By way of counterclaim, the Defendants alleged fraud against the Plaintiff and breach of its common law duty of care to its customer claiming that the 1st Defendant had suffered substantial loss and damage for which they claimed, among other, declarations that the guarantees of the 2nd- 7th Defendant were invalid and unenforceable, indemnity in relation to any losses suffered by the guarantors and damages for negligence and/or breach of contract.
The issues for determination by the court were;
1. Whether the five loan facilities were disbursed by the plaintiff in accordance with the facility agreements or at all?
2. Whether the 2nd to the 7th Defendants or any of them are liable to the Plaintiff as guarantors in relation to the 5 facilities or any of them?
3. What remedies are available to the parties?
The ground for the Defendants was;
that the original contract they entered into as guarantors had been altered and that the purpose of the loan was to buy fish based on accurate and confirmed orders payable by those companies that would be supplied the fish.
They contended that the idea was dropped along the way by corrupt officials to the bank particularly Robert Kasekende and Riyaz Kurji.
Section 68 of the Contracts Act, 2010 defines a “contract of guarantee” means a contract to perform a promise or discharge the liability of a third party in case of default of that third party, which may be oral or written”
Section 72(1) of the Contracts Act, 2010 points out the general rule that “the continuing guarantee may with regard to future transactions, be revoked by a guarantor at any time, by notice to a creditor”
Therefore, under what circumstances can a guarantor be discharged?
The Judge Ruled as follows;
Discharge may occur where the bank releases the debtor or gives him more time to pay. The discharge is based on the fact that the guarantors’ right at any time to pay the debt and sue the principle in the name of the creditor is interfered with; Section 74, 75, 76, and 80 of the Contracts Act, 2010 explains more about the discharge of guarantor.
In the Case of Triodos Bank NV Vs Ashley Charles Dobbs [2005] EWCA CIV 6 it was held that discharge may occur if there is a material change in risk being a guarantee. It should also be known that any factual matter that is likely to increase the risk of default by the principle represents a material alteration of risk. Where a creditor materially alters the terms of a guarantee after signature, the guarantee will be completely discharged.
In fact, once that happens, you cannot even revert to the original terms. The reason for this is clearly stated in Master Vs Miller (1791) 4 T.R.320 that;
“No man shall be permitted to take the chance of committing a fraud, without running the risk of losing by the event when it is detected”.
The guarantor must however show potential for prejudice as a result of the alteration if he is to benefit from the protection of the rule.
Judgment
Judgment is therefore entered in favor of the Plaintiff against the 1st Defendant in the sum of USD$3,706,895 and Ugx7, 003,733,847/= as claimed for the Plaintiff.
The 2nd – 7th Defendant counterclaimed for indemnity by way of damages in relation to any loss suffered by them as guarantors.
No evidence was led to this effect thus it remained unproved. This prayer is accordingly denied. However, the 2nd- 7th Defendants having been discharged from their obligations as guarantors are entitled to costs of the instant suit which shall be paid by the 1st Defendant.
In conclusion; -
The guarantor may be discharged according to Sections 74, 75, 76 and 80 of the Contracts Act, 2010. Though section 77 of the same Act gives an exception that “Where a contract to give time to a principal debtor is made by a creditor with a third person and not with the principal debtor, the guarantor is not discharged.” This shows that if the debtor is given time in the contract, the discharge of the guarantor does not take place.
Whereas termination of the guarantee in banking means only that the guarantor is excused from all further liability incurred by the debtor. The guarantor will not be excused liabilities that have already been accrued[3].
Where the guarantor guarantees the debit balance of a bank customer’s current account the ruling in Clayton’s case will have the effect of gradually discharging the guarantor’s liability if payments are made to the credit of the account since the debts for which the guarantor became liable were ‘fixed’ at the time the guarantee was terminated.
By SETIMBA EDRINE Currently in LLB3,
Uganda Christian University (UCU)
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