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Why Should Businesses Take Legal Advice Before Giving Corporate Guarantees?

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Why Should Businesses Take Legal Advice Before Giving Corporate Guarantees?

Why Should Businesses Take Legal Advice Before Giving Corporate Guarantees?

BK Singh Advocate: When you sign a corporate guarantee you may feel you are just signing another business document. This maybe where one company (often a parent company) wishes to support a subsidiary company, group company or business associate for the purposes of obtaining finance. The reality is very different. By signing a corporate guarantee you are voluntarily creating potential legal and financial liability for your company.

In general terms, a corporate guarantee will be a commitment by one company to be responsible for certain obligations of another party if that party defaults. The extent of the liability will depend on the wording of the guarantee itself, the underlying transaction, the relationship of the parties and the relevant legal provisions.

Directors, promoters and business owners should therefore treat giving a guarantee as a corporate decision. Obtaining legal advice prior to giving a corporate guarantee allows the company to understand its exposure prior to being contractually bound.

We recommend that when asked to provide a guarantee, businesses review not just the guarantee itself, but also the underlying transaction. Careful review of the proposed guarantee can highlight key provisions relating to liability, default and invocation, term and duration, indemnity, security and termination.

It is understandable that many companies see only the commercial benefit of signing immediately. A lender may need the guarantee to be executed before it will approve the finance. Or perhaps your group company requires financial support to complete a transaction. The pressure to execute can be immense. However the company providing the guarantee should always consider the consequences if the underlying borrower defaults.

Can a Corporate Guarantee Affect a Company's Financial Position?

Yes. A corporate guarantee is a potential liability even if no cash outflow is required immediately.

Imagine that an organisation guarantees a large loan acquired by a related party. The borrower may be able to service each repayment when it is due. However, economic circumstances can change and the borrower could run into financial trouble. The guarantor could be confronted with a large claim if the guarantee is invoked.

This risk can impact upon budgeting, cash flow considerations, financing negotiations and the commercial position of the company as a whole.

For that reason it is prudent for management to consider both the financial strength of the principal debtor and its own capacity to absorb such a claim.

Just because a borrower is a related party or trusted business associate does not mean that a guarantee should be considered risk free.

Why Should Businesses Take Legal Advice Before Giving a Corporate Guarantee?

Simply because: the supply of a guarantee exposes the guarantor to liability for a transaction to which it has not itself entered into.

A guarantee could be supplied by the company due to a group structure, long term commercial relationship, investment opportunity or at the request of a lender. Commercial reasons for supplying a guarantee do not negate the legal effect of the instrument.

Prior to execution, the company should be aware of:

  • The obligation which is being guaranteed.
  • The maximum exposure.
  • The timing for invocation by the beneficiary.
  • Whether the guarantee is limited or continuing.
  • The consequences of default by the principal borrower.
  • Whether there are indemnity/reimbursement provisions.
  • Whether any corporate authorisation is required.
  • Whether the transaction is permitted by the company’s constitutional documents.

BK Singh Advocate guides companies through these issues prior to a commitment being given.

What Corporate Approvals May Be Relevant?

Corporate guarantees often require statutory and internal approvals. The exact requirements will depend on the facts such as the nature of the transaction, the relationship between the parties, the amount involved, the provisions at play and the corporate structure etc.

The Companies Act, 2013 has various provisions relating to loans, guarantees and investments made by companies. Section 186 has application to certain corporate guarantees and related transactions. Section 185 can come into play during certain transactions with directors and related persons.

The Articles of Association, powers of the board, shareholder approvals, existing borrowing agreements and financial covenants are some other areas which would need to be reviewed depending on the facts.

Care should be taken not to assume that getting a signature from an authorized director is all that is required.

BK Singh Advocate can review the transaction and corporate records to determine what approvals and documents may be applicable.

Why Is the Underlying Agreement Important?

One should not read a corporate guarantee in isolation from the transaction.

If the company is guaranteeing a loan facility, the facility/financing agreement would typically set out the borrower’s covenants, events of default, repayment terms, security for the loan, interest rate and other key terms.

When one reads the underlying agreement, they know what it is exactly that the guarantor is guaranteeing.

Similarly, if the company is asked to provide a commercial guarantee in respect of supply commitments, performance obligations, leases, project finance, etc. reading only the guarantee would not give one a clear picture of the commercial risk which would be revealed only after reading the underlying agreements in context.

As advised by BK Singh Advocate, read the underlying agreements before a company agrees to give a guarantee.

Does the Relationship Between Companies Matter?

The relationship between guarantor and principal obligor may be significant to the transaction.

A parent company may guarantee the obligations of its subsidiary. A group company may back another to help it secure funding. Commercial parties may give mutual commercial comfort as part of a larger transaction.

But a corporate connection between guarantor and beneficiary does not necessarily eliminate the risk of a guarantee.

Due diligence should still be done on the financial position of the beneficiary, reason for the transaction, ability to repay, current indebtedness, and potential repercussions of default.

BK Singh Advocate can help companies understand the legal and commercial implications of providing a guarantee.

What Documents Should Be Reviewed Before Giving a Corporate Guarantee?

Reviewing documents can help you gain a better understanding of what you are committing to.

Depending on the transaction, this may include:

  • draft corporate guarantee
  • loan or facility agreement
  • sanction letter
  • security documents
  • board resolutions
  • memorandum and Articles of Association
  • existing borrowing facilities
  • existing guarantees
  • financial statements
  • corporate records
  • correspondence with lender/beneficiary
  • any documents referred to in relation to the principal borrower

The specific documents will vary depending on the circumstances of the transaction.

Companies should also keep clear records as to why the guarantee was provided, what authorizations were received and what obligations are being guaranteed.

What Happens If the Principal Borrower Defaults?

When the principal debtor defaults, the guarantee comes into play. The person who benefits from the guarantee can demand payment as per the guarantee and the law.

What position the company is in will depend on the terms of the document, the underlying obligation, the type of demand made, any contractual protections and the surrounding facts.

For this reason a guarantor should not treat any demand as some standard office correspondence. The letter should be examined quickly to ascertain what is being claimed and what the contractual position is.

BK Singh Advocate can help review a demand under a guarantee (or any similar legal letter) and explain the legal position.

Can Businesses Negotiate Corporate Guarantee Terms Before Signing?

The parties can sometimes bargain over contractual terms prior to execution depending on the bargaining power of the parties and the needs of the transaction.

A company may want to know how far it stretches; what is the extent of liability? How long? What obligations are covered? On what release? On what invocation? Etc.

You won’t be able to get everything you ask for. Some requests just aren’t commercially viable for the promisee. Remember the goal of legal review is not to believe that everything can or should be struck. It is to know what you are signing up for.

BK Singh Advocate can assist you with identifying terms that warrant your scrutiny when bargaining over a contract.

When Should a Business Consult a Corporate Lawyer?

Ideally legal review should take place before the corporate guarantee is executed.

Professional legal review of a corporate guarantee should be considered by the company whenever:

  • A lender requests a corporate guarantee.
  • A parent company is asked to guarantee the debt of a subsidiary.
  • A group entity seeks financial support from another member of the group.
  • The exposure under the guarantee is substantial.
  • The guarantee includes continuing obligations.
  • Existing guarantees have exposed the company to financial risk.
  • The company receives a draft invocation or demand.
  • The company is asked to renew or amend an existing guarantee.

Assistance is normally much more helpful before a party has entered into an obligation.

How Can a Corporate Law Firm Help?

Corporate Law Firm deals with businesses in regards to corporate documents, commercial agreements, guarantee reviews, compliance issues and business transactions.

BK Singh Advocate deals with corporate guarantee issues by reviewing the proposed guarantee and associated transaction and corporate documents with an emphasis on what the business is committing to, exposing itself to and what documentation should be put in place.

Businesses may want a review of guarantee provisions, contractual issues, corporate approval issues and issues resulting from an invocation or proposed enforcement.

Every corporate guarantee issue is different. It depends on the specific documents, parties, structure of the transaction, specific provisions and facts.

Businesses have the option to meet with BK Singh Advocate prior to issuing a corporate guarantee so that the obligation is understood from a legal and commercial standpoint.

Frequently Asked Questions

1. What is a corporate guarantee?

A corporate guarantee is a promise by a company in respect of certain obligations of another party. The extent and enforceability of such guarantee depends on the terms of the guarantee and the governing law.

2. Why should a company take legal advice prior to executing a corporate guarantee?

Legal advice would help understand the liability being incurred, circumstances in which the guarantee can be invoked, its duration, approvals required to be obtained, any indemnities and other risks before signing the guarantee.

3. Can a parent company execute a guarantee on behalf of its subsidiary?

A parent company can execute a guarantee in favour of its subsidiary depending on the applicable law, any corporate approvals required to be obtained, the requirements of the transaction and the constitutional and statutory framework of the company.

4. Is Section 186 of Companies Act applicable to corporate guarantees?

Section 186 has certain provisions relating to loans, guarantees and investments by companies. Whether the section applies to a particular transaction would depend on the facts of the transaction, whether any statutory conditions or limits are required to be complied with and any exceptions that may apply.

5. Can a corporate guarantee result in financial liability?

Yes. If the underlying obligation is not performed, the guarantee when invoked would be enforceable and the guarantor would become liable as per the terms of the guarantee and applicable law.

6. What should be reviewed before a company signs a guarantee?

The following should be reviewed by a company prior to signing a guarantee – the obligations being guaranteed, any limits on liability, invocation provisions, duration of the guarantee, indemnities, any defaults or events requiring approvals to be obtained and the underlying transaction documents.

7. Should the underlying loan agreement be reviewed?

Yes. Review of the underlying agreement would help the guarantor understand the obligations being guaranteed, defaults under the agreement, repayment obligations and other provisions.

8. Can the terms of a corporate guarantee be negotiated?

Contractual terms can be negotiated before executing the agreement, depending on the nature of the transaction and bargaining position. Legal review would help identify specific provisions requiring clarification/negotiation.

9. What should a company do upon receipt of a guarantee invocation?

Upon receipt of a guarantee invocation, the company should quickly review the guarantee, underlying transaction, demand and all related records. Legal advice would assist the company to understand its legal position and possible responses.

10. How can BK Singh Advocate help you with respect to corporate guarantees?

BK Singh Advocate can review your guarantee and related contracts, check for corporate compliance requirements, identify any contractual issues and advise you on the legal position.

Final Thoughts

Providing a corporate guarantee can enable a business transaction. However, it can also expose the company providing the guarantee to significant liabilities. The commercial benefit of assisting another party’s business should be weighed against potential financial and legal exposure.

Prior to executing a guarantee, a company should understand the extent of the guarantee obligation, the underlying transaction, events of default and guarantee invocation mechanics, term, indemnification obligations and related corporate requirements.

Timing is important when reviewing legal documents. Therefore, obtaining legal advice prior to execution will generally allow the company more opportunity to identify issues while the terms are still negotiable.

BK Singh Advocate can help companies review corporate guarantees, associated commercial documentation, obtain required corporate approvals and address legal issues resulting from operations under a guarantee.

If your company is asked to operate under a corporate guarantee, please consult Advocate BK Singh prior to execution of the document. A review specific to your situation can help you understand your legal position and make an informed commercial decision.

Author Bio

BK Singh Advocate offer corporate and commercial legal help, relating to corporate guarantees, commercial contracts, corporate paperwork, business dealings, and compliance issues. BK Singh Advocate can help businesses, startups, entrepreneurs, directors, or business owners to review your documents and navigate you through potential legal ramifications. BK Singh Advocate has a practical approach to helping you with document review and making informed business decisions from a legal perspective. Corporate Law Firm offers skilled corporate legal advice. Whether it be based on the facts of the deal, structure of the transaction, law applicable to the business and requirements of your business.

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Adv. BK Singh

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Practicing before the Supreme Court, High Courts, and tribunals, we handle Legal matters with strong expertise and a result-oriented approach.

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