Of everything in a facility agreement, the guarantee is the clause borrowers accept most quickly and regret most often. It is presented as standard, it costs nothing on the day it is signed, and it is the only term that can follow a person after the asset is gone.
It is worth being unsentimental about what a guarantee is: a promise that if the borrower does not pay, the guarantor will, from whatever they own. Not from the asset that was financed. From everything.
When a lender is genuinely entitled to ask
There are cases where a guarantee is a reasonable request. Where the loan to value is high enough that a fall in value would leave the lender short. Where the borrower is a newly formed company with no history. Where the transaction depends on the borrower doing something, such as completing a building, and the lender wants the person responsible to have skin in the outcome. Where there is construction risk, a completion guarantee narrowly drawn to that risk is a normal market term.
And there are cases where the request is simply a negotiating position: full first charge security at a conservative loan to value, a liquid asset, an experienced borrower, and a personal guarantee on top because nobody pushed back. That is worth recognizing, because it is negotiable in a way the interest rate frequently is not.
The forms it takes, and they are not equivalent
A guarantee can be joint and several, meaning the lender can pursue the guarantor directly without first exhausting the borrower or the security. It can be limited to an amount, to a period, or to a specific obligation such as completion or the accuracy of information given. It can fall away on a trigger, such as the asset reaching a stated valuation or a certain proportion of the debt being repaid.
The difference between an unlimited joint and several guarantee and one capped at a stated figure that releases on a defined event is the difference between two entirely different transactions. Borrowers sign the first believing they signed the second.
Nobody negotiates a guarantee once it has been called. The only moment it can be shaped is the moment it feels least important.
What the law fills in when the document is silent
Dutch law regulates the guarantee by which a guarantor binds himself to the creditor to perform an obligation the borrower has or will have, the borgtocht of Title 14 of Book 7 of the Dutch Civil Code. Article 7:850 applies the rules on joint and several obligations to it, except where the title departs from them, and article 6:7 of Book 6 of the Dutch Civil Code gives the creditor of joint and several debtors a claim against each of them for the whole. The guarantee depends on the obligation it secures (article 7:851), the guarantor can raise the borrower’s defences that concern the existence, the content or the time for performance of that obligation (article 7:852), and the guarantee is extinguished once the limitation period for the claim against the borrower has run (article 7:853).
Two rules in the same title matter most when a loan goes wrong. The guarantor is not bound to perform before the borrower has failed to perform, and a lender that gives the borrower notice of default under article 6:82 of Book 6 must notify the guarantor at the same time (article 7:855). What Title 14 does not contain is a right for the guarantor to insist that the lender first enforce against the borrower or the security. Where that sequence is wanted, it has to be written into the document.
Spanish law starts from the opposite position. Article 1830 of the Spanish Civil Code provides that the guarantor cannot be compelled to pay the creditor until the debtor’s assets have been pursued, which is the benefit of excussion. Article 1831 sets out the cases in which that benefit does not apply, among them an express waiver by the guarantor, a guarantor who has bound himself jointly and severally with the debtor, the debtor’s bankruptcy or insolvency proceedings, and a debtor who cannot be sued in the courts within Spain. Even where it applies, article 1832 requires the guarantor to raise it as soon as the creditor demands payment and to point to assets of the debtor, realisable in Spanish territory, that are sufficient to cover the debt. Where the guarantee secures a commercial contract, article 439 of the Spanish Commercial Code treats it as commercial even if the guarantor is not a trader, and article 440 requires it to be in writing, failing which it has no value or effect.
What to negotiate, in order of value
A cap, expressed as an amount rather than as a proportion of something that can move. A release mechanism tied to an event that will actually occur, such as repayment below a threshold or practical completion, rather than to the lender’s discretion. A requirement that the lender enforce the security first, before pursuing the guarantor. Exclusion of default interest and costs from the capped amount, since these can quietly double an exposure. And an end date.
Where two or more people guarantee together, the allocation between them matters as much as the total. Joint and several liability between partners means the lender can pursue whichever of them is easiest to reach, and the one who pays is left to recover from the others. A side agreement between guarantors is cheap to draft and valuable exactly once.
The default rules on several guarantors differ by country. In Spain, article 1837 of the Civil Code divides the liability among several guarantors of the same debtor for the same debt, so that the creditor can claim from each only his share unless joint and several liability has been expressly stipulated, and that benefit of division ceases in the same cases and for the same reasons as the benefit of excussion. Between the guarantors, article 1844 allows the one who paid to claim from each of the others his proportional share, with the share of an insolvent guarantor falling on the rest in the same proportion, but only where the payment was made under a court claim or while the debtor was in insolvency proceedings. In the Netherlands, article 7:869 allows the guarantor at whose expense the debt was discharged to spread the part that proves unrecoverable over himself, his co-guarantors and the non-debtors liable for the obligation, applying article 6:152 of Book 6.
The protection the law gives a private guarantor, and who falls outside it
Book 7 adds a second layer for one kind of guarantor. Under article 7:857 section 2 of Title 14 (articles 7:857 to 7:864) applies to guarantees given by a natural person who acted neither in the course of a profession or business, nor for the normal conduct of the business of an NV or a BV of which he is a director and in which he, alone or together with his fellow directors, holds the majority of the shares.
For a guarantor inside that definition the protections are specific. Where the amount of the borrower’s obligation is not fixed when the guarantee is given, the guarantee is valid only to the extent that a maximum amount expressed in money has been agreed (article 7:858), although the statutory interest and costs owed under article 7:856 can be claimed regardless of that maximum. The guarantee can be proved against the guarantor only by a document he has signed, subject to the exception in article 7:859 for a guarantor who has already performed in whole or in part. A guarantee given for future obligations can be terminated at any time if it was not given for a fixed period, or after five years if it was, and it continues for the obligations that have already arisen (article 7:861). Article 7:862 identifies what cannot be varied to the guarantor’s detriment.
The practical consequence runs against intuition. The founder who is a director of the borrowing BV, who alone or with fellow directors holds the majority of its shares, and who signs for its normal business, is outside article 7:857 and has none of these protections by law. A spouse or relative who signs without acting in a profession or business, and without being in that position, may be inside it. For the founder, Title 14 does not supply the maximum amount or the termination right that it gives a private guarantor, and article 7:862 does not prevent the document from departing from articles 7:852 to 7:856 to his detriment, which is why the points in the previous section carry more weight for that guarantor than for anyone else.
Corporate guarantees carry different problems
When the guarantor is a company rather than a person, the questions change but do not disappear. The guarantee has to be within the company’s objects and permitted by its constitution. Its directors have to be able to show corporate benefit, because giving away the company’s credit for no return is a decision that can be examined later, particularly if the group runs into difficulty. In the Netherlands this connects directly to directors liability in a Dutch BV.
In the Netherlands the consequence of exceeding the objects is set by article 2:7 of Book 2 of the Dutch Civil Code: the act is voidable if it exceeded the objects and the counterparty knew this or, without its own enquiry, must have known it, and only the company itself can invoke that ground. Guarantees connected with the purchase of shares meet a separate rule for the NV. Article 2:98c prohibits the company and its subsidiaries, with a view to the taking or acquisition of its shares, or of depositary receipts for them, by others, from giving security, giving a price guarantee, otherwise standing surety, or binding themselves jointly and severally or otherwise alongside or for others, subject to the exceptions in paragraphs 8 and 9 of the article. The same prohibition for the BV, formerly article 2:207c, was repealed with effect from 1 October 2012.
There is also a transfer pricing dimension that groups regularly overlook. A guarantee has economic value, and where it is given across borders between related parties it should be priced and documented. In the Netherlands that follows from article 8b of the Dutch corporate income tax act, under which, where one entity participates directly or indirectly in the management, supervision or capital of another, or the same person does so in both, and the conditions agreed or imposed between them differ from those that independent parties would have agreed, their profits are determined as if the conditions independent parties would have agreed had applied, and which requires the entities to keep records showing how their transfer prices were set. We set out the approach in our note on pricing debt inside a group. Unpriced guarantees sitting in a group structure are a standing invitation for an adjustment.
What a guarantee should tell you about the deal
Read the request diagnostically. A lender that wants a broad personal guarantee on a conservatively leveraged, liquid asset is telling you it is not confident in the asset, the exit, or the borrower. That is information worth having before signing, and sometimes worth acting on by not signing.
Conversely, a lender that accepts a capped guarantee limited to completion risk, releasing on delivery, has understood the transaction. The negotiation over the guarantee is often the clearest signal available about whether the lender has actually underwritten the deal or is relying on the borrower to make good whatever it has not analysed. The same principle runs through our note on where non-bank finance fits.
Montclare structures and arranges financing secured on European assets, and prepares the corporate and tax structure that sits behind it. Our services are set out on our services page.
This article is informational and does not constitute tax, legal or financial advice. Lending and credit intermediation are regulated activities and the treatment of any transaction depends on its facts. Each engagement is subject to scope and applicable regulation.