In March 2009, amid the early days of the recession, the Bank of England reduced the interest base rate to 0.05% and it has remained at this level ever since. The reduced rate has benefitted homeowners and borrowers whom have been able to take advantage of the favourable mortgage and lending rates.
This in turn has also reduced the number of homes being repossessed in the UK as fewer owners fell behind on mortgage repayments. The Council of Mortgage Lenders (CML) has recently reported that 2,500 homes were repossessed in April, May and June of this year – down from 3,000 in the previous quarter.
Unfortunately the low interest rate cannot last forever and lenders have warned that homeowners and borrowers must be prepared for a rate rise – it is believed that more than a million homeowners have never experienced a rise in the Bank of England’s base rate while owning a home.
Third party security
Lenders often require security from a third party, especially if the loan is to be used for commercial or business purposes. The security is usually in the form of a personal guarantee from a director or owner of the business which grants the lender a charge over their home to be enforced in the event of default.
If a lender is therefore seeking to enforce its third party security, what are your rights?
What is a guarantee?
A guarantee is a promise by Party A to a lender to ensure that Party B fulfils its obligations and/or a promise to fulfil those obligations if Party B fails to do so – essentially, the guarantor (Party A) promises the lender that the borrower (Party B) will perform its obligations and, if it does not do so for any reason, shall perform them on its behalf.
A guarantee is contingent on the borrower’s primary obligation to the lender and therefore the guarantor’s liability will never be greater than that of the borrower.
Key legal issues affecting guarantees
- Contractual issues and formalities
Guarantees and indemnities must conform to the basic requirement of a contract must be in writing and signed by the guarantor or a person authorised by the guarantor.
Guarantees are usually executed as a deed –it is worth checking the document to ensure the execution formalities are correct and binding.
If the guarantee is being given by a company or corporate entity then it should have an express power to do so either in its memorandum or in its articles of association.
If the directors exercise an ancillary power of the company, they must show that they are acting to further the objects of the company and there is no abuse of power. It is important for the directors to show that they are acting to promote the success of the company as a result of entering into the guarantee.
If directors do not have the relevant capacity to bind the company then the guarantee may be unenforceable.
- Unfair Contract Terms
Where the guarantee is in a standard form, it will be subject to the test of reasonableness and fairness. If a term in the guarantee fails these tests and is defined as an unfair term, it will not be binding on the guarantor.
The tests of reasonableness and fairness do not however apply if the guarantee is given by a company director or a partner in a limited liability partnership.
- Undue influence and misrepresentation
Undue influence and misrepresentation can arise, for example, in husband and wife relationships or a relationship whereby a fiduciary relationship exists. In the leading case of RBS v Etridge, the House of Lords confirmed that, subject to a number of exclusions, a lender is put on notice of undue influence and/or misrepresentation where a wife is to guarantee the debts of a company and the shares are held by both the husband and wife.
So as to avoid potential undue influence and misrepresentation issues arising, a lender should;
- insist that the guarantor attend a private meeting with the lender to be told the extent of their liability and be warned of the risks; and
- request that the guarantor take separate independent legal advice and provide confirmation, from the relevant solicitor, of the advice given.
In the event the above steps have not been taken then the guarantee is likely to be unenforceable.
Persons considering giving a personal guarantee should be aware that, subject to the terms of the security document, a lender is usually at liberty to enforce the guarantee even when they hold security over the assets of the principal borrower – accordingly, the lender may choose to enforce its security against the guarantor before, or in place of, the principal borrower.
If you are involved in a dispute relating to enforcement of financial security and would like advice on this or a related topic, please contact Richard Slater on 01392 210700 or email firstname.lastname@example.org. Richard is a member of the Dispute Resolution Team in Exeter and specialises in commercial litigation. He advises on a wide range of matters relating to contractual and financial services disputes.