This blog was co-authored by Atish Dullabh, candidate attorney at Norton Rose Fulbright South Africa.
In June 2023, the Western Cape High Court ruled that a guarantor does not have an automatic right of recourse against a principal debtor to recover payment made to a beneficiary in terms of a guarantee. The ruling in this judgment describes the legal relationship of a guarantor in relation to a beneficiary and a principal debtor, which should be borne in mind by financial institutions before issuing a guarantee.
The plaintiff bank issued two guarantees in favour of the defendant’s creditor. When the creditor claimed payment from the plaintiff in terms of the guarantees, the plaintiff, after settling its debt with the creditor, sought to recover its payment from the defendant on the basis that a guarantor has automatic recourse against the principal debtor analogous to that of a surety.
The legal issue was whether a guarantor has an automatic right of recourse against a principal debtor to be indemnified for payments made to a beneficiary/creditor under a guarantee.
The court rejected the proposition that a guarantor, like a surety, has an automatic right of recourse against the principal debtor, on the following three grounds:
- a guarantee is intended to indemnify the creditor by imposing an independent obligation on the guarantor to pay the creditor if a specific event occurs;
- conversely, a surety’s obligation is ancillary to the principal debtor’s obligation, and not independent, which obliges the surety to pay the creditor only if the principal debtor defaults and not if other specified events occur; and
- a guarantor is not entitled to compensation from the principal debtor who was not party to the independent guarantee between it and the beneficiary, because a guarantor settles its own debt (not the debt of the principal debtor) when payment is made in terms of the guarantee.
In financing arrangements, guarantees are often termed as providing “security” for a borrower’s obligations. A guarantee is usually provided in the finance world as credit enhancement for the lender but may be provided as security. Either way it imposes an independent obligation on the guarantor to pay a beneficiary on events not strictly confined to a borrower’s default. A guarantee offers a stronger form of undertaking than a surety by creating primary obligations, but does not automatically offer a right of recourse against the principal debtor like a suretyship.
Given that a guarantor does not have an automatic right of recourse against a principal debtor, a guarantor seeking to obtain indemnity from a principal debtor should take an adequate counter-indemnity/guarantee from the debtor who will benefit from the payment (and from other creditworthy security providers if available).
Nedbank Limited v Xanita (Pty) Limited (885/2019) [2023] ZAWCHC 144 (12 June 2023)
The plaintiff sought to appeal this judgment. However, the application for leave to appeal was dismissed (link below).