Suretyship and guarantees are important mechanisms in our economy. They act as a safety net for transactions both big and small. This begs the question: what is the difference between a guarantee and a suretyship?
The main distinction, which will be discussed in more detail below, is that the suretyship is based on accessory liability whereas the guarantee is based on primary liability.
A suretyship agreement is a contract which creates conditional liability between a surety and a creditor. The characteristics of a suretyship agreement are that it is has secondary and accessory liability. Secondary liability means that the surety agrees to pay an amount conditional upon the fact that the debtor defaults on his obligations. If the debtor does not default on his obligations, the creditor cannot call upon the surety.
Accessory liability, otherwise referred to as auxiliary liability, means that the validity of the surety depends wholly on the validity of the principal debt. In other words, if the principal debt is extinguished, liability arising from the suretyship agreement will be extinguished simultaneously.
An accessory guarantee is closer to a suretyship than an independent guarantee. This means that liability in terms of an accessory guarantee is dependent upon the underlying contract. If there is a dispute regarding the performance of one of the parties then an accessory guarantee will only be payable once the dispute has been resolved. An independent guarantee therefore exists independent of the underlying obligation.
The second distinction is that common law suretyship agreements had various defences which protected the surety. An example of one of these defences would be the beneficium excussionis.
This defence gave the surety the right to refuse payment until the creditor obtained as much of the debt as possible, from the principal debtor. Modern day suretyship agreements contract out of these common law defences which could leave the surety in a precarious position.
There are only a few defences to an independent guarantee. Fraud is the most common, well recognised, exception and only absolute defence to the enforcement of an independent guarantee.
However, it is difficult to prove. Another defence to the enforcement of an independent guarantee is that the demand for payment does not adhere to the requirements as set out in the guarantee agreement.
The third distinction is the enforcement of these agreements. The enforcement of an independent guarantee is more effective than that of a suretyship.
An independent guarantee can be demanded once the conditions of the guarantee have been met. Normally the conditions are that the beneficiary must allege some form of breach and attach a notice of cancellation. Independent guarantees are similar to letters of credit. Both are subject to the principle of independence.
The principle of independence means that the guarantee is separate from the underlying contract. This means that any dispute regarding the contractual relationship will not affect the guarantors’ obligation to pay. In other words when the guarantor is called upon to make payment, its only duty is to determine whether the conditions set out in the guarantee have been met.
The guarantor is not obliged or even allowed to investigate the underlying relationship between the parties. The guarantor is duty bound to make payment upon conforming demand.
The doctrine of strict compliance normally only applies to letters of credit. However, there has been a lot of academic discussion regarding whether the doctrine of strict compliance should apply to guarantees.
The doctrine of strict compliance entails that the beneficiary must comply with the requirements in the guarantee. If the requirements are not strictly adhered to, the guarantor may not pay the guarantee.
The question of whether or not guarantees are also subject to the doctrine of strict compliance remains unanswered. That being said no guarantor will pay if the requirements of the guarantee are not met. Any guarantor who attempts to do so is acting outside of his mandate.
The fourth distinction between a suretyship and a guarantee is that a suretyship is only valid if it adheres to the following formality requirements: section 6 of the General Law Amendment Act 50 of 1956 states that the suretyship agreement will only be valid if it is in writing and signed by or on behalf of the surety.
A guarantee does not have any formal requirements. However, it is strongly advisable to place it in writing for certainty and evidentiary purposes.
As can be seen from the above discussion, suretyships and guarantees have the same function: to ensure the guarantor or the creditor is not out of pocket. However, they have diverging characteristics which should be taken into account when deciding which type of security agreement to use.