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LIABILITY OF A SURETY IN A SURETYSHIP AGREEMENT

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Article by Mzo Tshaka of Schoeman Law 

Introduction

In simple terms, a suretyship agreement is an agreement in terms of which one person (the surety) undertakes to a second person (the creditor) to fulfil the obligations of another person (the principal debtor). Therefore, a typical suretyship arrangement involves three separate parties: the creditor, the debtor and the surety.

Whereas there will be an underlying agreement between a debtor and the creditor, typically there will be no underlying agreement between a surety and the creditor apart from the suretyship agreement.

This article addresses a very limited aspect of suretyship agreements: the extent of liability. A classic example involves a situation where a landlord (the creditor) concludes a commercial lease agreement with a tenant company (the principal debtor) and, in terms of that lease agreement, the landlord then insists that the director/owner of the tenant company (the surety) must sign a suretyship agreement under which the surety undertakes to fulfil the tenant’s obligations if the tenant defaults on their obligations. In such a scenario, it is evident that the surety’s liability depends on the tenant defaulting. As long as there is no default, the landlord will have no claim against the surety.

It is important to note that:

·         In almost all suretyship agreements, the creditor would want the person signing surety to also bind themselves as co-principal debtors. This results in the surety being liable in the same manner as the principal debtor, which means the creditor is able to recover the debt owing directly from the surety without first trying to recover from the principal debtor. This may be particularly useful for the creditor where, if we use the example above, the tenant company is liquidated or is simply unable to pay its debts for one reason or the other. In this case, the landlord would not have to first try to get payment from the tenant company with financial difficulties. Instead, the landlord would go directly to the surety.

·         The surety’s undertaking may be for a limited or unlimited time. For example, the surety in the example above may stipulate that they will be liable for the tenant’s debts up to a specified amount and provided such debts arose during a specified period.

·         However, in some suretyship agreements, which are the most common, the surety undertakes unlimited liability, which applies to many different transactions that need not be identified separately. These suretyships are called continuing suretyships.

·         In the case of a continuing suretyship, the surety’s liability extends to a series of debts and/or transactions. These transactions or debts may relate to some future debt to be incurred or to an existing debt already incurred by the principal debtor.

With continuing suretyships, it is important to note that suretyship agreements are not automatically cancelled once the debt has been repaid; or when the business for which the surety was originally signed has been sold; or even if the surety dies. The creditor must release the signatory from such an agreement − in writing.

In the lease agreement example above, let us assume that the surety had also bound themselves as a co-principal debtor, but their liability was limited to R100 000, with rent payable by the tenant at R50 000 a month. If the tenant defaults on their rent for January, February and March, a total of R150 000, and the landlord, without cancelling the lease agreement, calls on the surety to settle the amount then outstanding, the landlord would only be able to recover R100 000 from the surety. The landlord would have to recover the outstanding R50 000 from the principal debtor. This shows the importance of having a capped amount if you are standing surety.

However, the surety’s exposure would not be limited to that R100  000 because if the tenant was to default again at a future date, say in April and May, the landlord would still be entitled to claim from the surety the amounts then due to a maximum of R100 000. This is because the April and May defaults would constitute a new cause of action for the landlord.

This demonstrates the importance of having a continuing suretyship if you are a creditor but, conversely, the dangers of having a continuing suretyship if you are the surety.

Furthermore, unless the suretyship agreement states that the agreement will terminate when the surety dies, the landlord would still be entitled to claim from the surety’s estate even if the principal debtor defaults after the surety has passed away. Similarly, if the person who signed the suretyship agreement was, for example, the owner of the company and they subsequently sell it to a third party, the surety may find themselves liable for debts incurred by a company they no longer have any influence over − unless the suretyship agreements are cancelled and the surety is released from such agreements.

Conclusion

It is essential that if you ever sign a suretyship agreement, you make sure you fully understand the nature and extent of the debt and how long you can be held liable for it. It is equally important to ensure that you are released from any suretyship agreements that may have been signed. They can potentially come back to haunt suretys long after they sign the suretyship agreement or long after any relationship between the surety and the principal debtor has been terminated.