What is a Suretyship?
A suretyship is an accessory contract. This means that it is a security held over a primary debt or obligation.
Entering into a suretyship agreement is commonplace in South Africa.
Suretyships are generally very onerous contracts. Whilst one is usually signing a Suretyship as a natural person, the Surety is only entitled to the same defences as the primary debtor, which is often a juristic entity (a company).
Therefore, if the underlying primary debt, usually with a juristic entity signing as primary debtor, arose from an agreement excluded from the National Credit Act and the Consumer Protection Act because, amongst other factors, the primary debtor was a juristic person, the Surety for that primary debt loses out on potential protection of the aforementioned legislation which protection they may have enjoyed had they signed in their personal capacity as the principal debtor as a natural person, as opposed to signing as Surety for the company.
Whilst suretyships are generally added as their own document, or as an annexe at the end of a contract, some creditors and lessors place “hidden” suretyship clauses inside a paragraph of the contract which the principal debtor is signing.
The enforceability (or lack thereof) of such “hidden” suretyship clauses often depends on how the agreement is structured, so it is essential to read any document you sign very carefully, and to seek legal advice before doing so.
As a suretyship is an accessory obligation to a principal debt by a principal debtor, if there is a valid defence to the principal debt and same, for example, becomes invalid, the surety may escape liability on this ground.
However, often the agreement for the principal debt is sound (or is not put under sufficient scrutiny) and the underlying debt is no longer in question, only the validity of the suretyship.
What happens if things go wrong?
When most people sign surety, they do not contemplate the principal obligation as being a problem for their company to meet. However, if the events of the Covid 19 pandemic and its detrimental effect on many South African’s financial position has reminded us of one thing, it is that nothing is certain, and that a principal debtor’s ability to pay back the debt or obligation can turn for the worst quickly. In that case, when the principal obligation is defaulted on, the principal debtor will call on the surety as being liable for that obligation.
While the very nature of a surety agreement is burdensome and has far reaching consequence there are a limited set of situations which might avail themselves and allow the surety to escape the surety obligation.
Depending on the circumstances, as well as the wording and structure of the Suretyship document itself, it is possible to escape liability as a Surety.
Only two very narrow surety-defences will be canvassed here, and this article is not exhaustive of all the possible defences that can be raised when a Surety is pursued.
Surety Defences I: Justified Error
Only two very narrow surety-defences will be canvassed here, and this article is not exhaustive of all the possible defences that can be raised when a Surety is pursued.
If there is a justified error as to the nature and contents of the surety that was signed and that error was the result of an act or omission of the other contracting party which induced the surety into a false belief of a certain material or integral term of the surety, the surety might be freed of the surety obligation. If the surety relies on an omission by another party, then it must be further proved that the other contracting party had a duty to speak. Generally, our law requires us to be aware of what we are contracting into and not to rely on the other contracting party to set out all the terms of the contract. The exception which must be proven in this case, is where the other contracting party has exclusive knowledge of a certain material aspect, which the signor had a right to know of and that would be acknowledged by honest contracting parties in the circumstance.
The High Court decision of Absa Bank Limited v Van Eeden and Others 2018 is illustrative of such a situation.
In this case, Absa lent R10 Million Rand to two companies for the development of a shopping centre. The companies then borrowed a further additional R5 Million Rand from ABSA, which registered a R5 Million Rand mortgage bond over the property as security.
The defendant, a natural person, also signed surety for the full value of R5 Million Rand on his personal behalf and on behalf of his family trust. The developer signed the surety agreements under a mistaken belief that were was enough equity in the property, which was valued at R12 Million Rand, to cover the R5 Million Rand bond and another bond of around R2.7 Million Rand.
However, there was a third bond of R15 Million Rand, that the defendant had no knowledge of at the time he signed the sureties. Neither the principal debtor nor ABSA notified the defendant of the third bond over the property.
Eventually the two companies whom the defendant stood surety for failed and at this point the defendant discovered that the property was over-bonded. ABSA then sued the defendant for approximately R5.7 Million Rand, being the surety value plus interest.
The defendant successfully escaped liability of the Suretyship by proving justified error. The court found that in the circumstances, the defendant would never have signed surety had he known of the R15 Million Rand bond over the property, and that ABSA were fully aware of his concern in relation to the equity in the property. The defendant believed there to be a relationship of trust between himself and ABSA, and consequently did not do a Deeds Registry search on the property, which would have revealed the R15 Million Rand bond. Finally, and of importance, the court decided that because the bank disclosed the R2.7 Million Rand bond and not the R15 Million Rand bond, that the bank made an incomplete disclosure in a situation where it had the duty to speak.
In Van Eeden the surety escaped liability due to the specific set of circumstances, however in Airports Company SA Ltd v Masiphuze Trading (Pty) Ltd and Others 2019, another recent High Court decision, the respondent failed in its attempt to rely on the same defence of justified error. In this case the respondent did not read a lease agreement which had an attached surety. The respondent failed to prove that any other party induced his error and that his error was justified unilaterally. This brings us back to the general position that one must be familiar with the terms of any contract entered into and that will be held to such agreement.
Surety Defence II: The “Lazy Man’s Surety”
This possible defence is far more untested by our courts than the previously mentioned defence and is therefore largely speculative at this stage.
Due to the wide use of suretyships in South Africa, certain terms have become common place.
This, however, has caused some suretyships to be oversimplified and these agreements, debatably, do not abide by the basic principles of suretyship law.
Section 6 of the General Laws Amendment Act 50 of 1956 (GLAA), makes it a requirement of a surety agreement that same is signed and reduced to writing.
Our Courts attempted to summarise the position regarding what content a surety agreement must have in order to comply with Section 6 of the GLAA, in Nedbank Limited v Wizard Holdings (Pty) Ltd 2010.
The Court found that the required terms of a contract of surety are the identity of the creditor, identity of the debtor, identity of the surety and the nature and amount of the principal debt. Failure to include all of these would render a suretyship invalid.
Regarding the content of these terms, the position of the Court is that explicit reference to the parties or the principal debt is not required, but merely broad reference to the parties or principal debt.
Let us now consider what is by and large the standard surety liability term, colloquially referred to as “the Lazy Man’s Surety” which states: The surety shall be liable for the due and punctual payment and performance by the debtor of all debts and obligations of whatsoever nature and howsoever arising, which the debtor may now or in the future owe to the creditor.
This term is generally couched before or after a reference is made to an identified principal debt or a number of classes of debts that may come into existence between the principal debtor and the creditor.
The possible debts are numerous, examples being; guarantees, bonds, loans, credit faculties and many more. The standard surety term coupled with reference to the principal debt, defines the nature of the surety agreement and clearly demarks the basis of the surety liability.
When, however, the standard surety liability term is left bare, with no reference to the principal debt or debts that the surety can be liable for, it is as if the surety liability has been left unlimited. With no limiting factor to the surety’s liability, such a suretyship may not comply with Section 6 of the GLAA, as the surety may be held liable for debts that the surety did not envisage.
Another situation which may invalidate a surety agreement, is when the agreement is left unlimited in liability and in duration. Distinct from the situation where the standard surety liability term is left without reference to the principal debts or classes thereof, it is accepted that a surety can be held liable for all future debts of a certain principal debtor and that consent is required from the creditor for release from the surety. If, however, the suretyship agreement contains an unqualified standard term coupled with an unlimited liability clause and a clause which restricts0 the release of the surety, then the surety would be in effect, liable unlimitedly and forever, for the debts of the principal debtor. This cannot have been the intention of the parties and such a suretyship may fall short of the requirements of the GLAA.
Conclusion
Entering into a surety attracts onerous liability and should not be done lightly and without first obtaining legal advice. The general position in our law is that you must abide by the contracts that you enter into. There are however certain limited situations when one may be able to escape a suretyship.
The information and material published on this website is provided for illustrative purposes only and does not constitute legal advice.
Please consult a lawyer on any specific legal issue. We accept no responsibility for any loss or damage, whether direct or consequential, which may arise from reliance on the information contained in these pages.