Guarantees and Surety Bonds

A clear distinction must be made between a surety bond and a

guarantee.

Difference between a Guarantee and a Surety Bond

Difference between a Guarantee and a Surety Bond

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Guarantee
A guarantee is a distinct promise to pay and is not dependent on the principal obligation. The
guarantor (the bank) may not raise any objections or defenses based on the underlying transaction.
This means the guarantor pays upon the first written demand (claim) on the part of the beneficiary, i.e.
on presentation of the confirmation specified in the guarantee text and any required documents.
The standard wording used by banks in individual cases either comply with the local legal framework
or the policies of the International Chamber of Commerce (ICC). The extent to which any policies apply
depends on the acceptance of the beneficiary, who decides in what manner, based on which law, and
following which policies a guarantee or standby letter of credit in his or her favor is accepted.

Uniform Rules for Demand Guarantees (URDG 758)

The URDG 758, which are a revised version of the URDG 458, came into force on July 1, 2010. Their
wording is based on the internationally recognized Uniform Customs and Practice for Documentary
Credits (UCP 600) issued by the ICC. For the URDG 758 to apply they must be explicitly agreed to in
connection with guarantees.
A widely used and noteworthy form of guarantee is the standby letter of credit introduced by banks in
the US to satisfy US banking law. In the same way as a guarantee, the standby letter of credit functions
as a guarantee independently of the contract concluded between the seller and the buyer. In a manner
of speaking, it is the counterpart to the European bank guarantee. The standby letter of credit secures
all claims that are normally secured by a guarantee.

International Standby Practices (ISP 98)

The ISP 98 were developed by the ICC specifically for standby letters of credit. Before the ISP 98 took
effect in 1998, standby letters of credit were issued subject to the Uniform Customs and Practice for
Documentary Credits (UCP 600). For the ISP 98 to apply they must be explicitly agreed to in connection
with standby letters of credit

Uniform Customs and Practice for Documentary Credits (UCP 600)

As global policies, the UCP 600 apply to all documentary credits. If applicable, they also govern all
standby letters of credit, although this requires that the UCP are explicitly agreed on when issuing the
standby letter of credit.

Surety Bond
A surety bond, pursuant to Art. 492 ff of the Swiss Code of Obligations, generally serves the sole
purpose of protecting the claims of Swiss creditors. The surety bond is completely dependent on the
principal debt relationship (accessoriness). The principal debtor may submit a written objection to the
bank regarding the principal debt, stating the reasons for non-payment. The bank, in turn, is obliged to
notify the beneficiary (creditor) of any entitlement to appeal on the part of the principal debtor (SCO,
Art. 502). In practice, this means that a bank acting as a surety will generally meet a claim from the
creditor only if expressly authorized to do so by the principal.

Distinction in Practice
If accessoriness is evident, it is a surety bond. In the absence of accessoriness, a guarantee has been
agreed. In contrast to a surety, the guarantor may not raise any objections or defenses based on
another debt obligation.

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DISTINGUISHING BETWEEN GUARANTEE AND SURETYSHIP

AGREEMENTS
NOVEMBER 2012

Introduction
As is widely known, legal transactions are formed upon consensus of declarations of intent. The purposes of
the parties engaging in the legal transactions are reflected in these declarations of intent. However, the parties
declarations of intent may not reflect the real intention of the parties at all times. In some cases, the real
intentions of the parties must be determined. The disputes arising in practice mainly originate from
determining the nature of the relationship between the parties, making it necessary to determine the rules
applicable to this relationship. Even though parties may define their relationship in a certain way, the
determination of the nature of the legal relationship between parties must be made according to their real
intentions[i]. This general rule is based on Article 18[ii] of the Code of Obligations numbered 818 (CO) and
Article 19 of the Turkish Code of Obligations numbered 6098 (TCO). Pursuant to the two articles specified,
while determining and interpreting the type and content of an agreement, the real and common intentions of
the parties shall be taken into consideration regardless of the words used by the parties by mistake or with the
intention to hide their real purposes.
Consequently, the legal nature of the relationship between the parties in all cases shall be determined by
considering whether or not the declaration of intent of the parties legally qualifies their relationship[iii].

Guarantee or Suretyship?
One of the circumstances which requires interpretation of the parties intentions under Turkish law is a dispute
concerning whether a security relationship between the parties is a guarantee agreement or a suretyship
agreement. This matter has been discussed in the doctrine and rulings of the Court for a long time[iv].
Determining whether the nature of the security relationship between parties is a guarantee agreement or a
suretyship agreement is essential, due to differences in the conditions concerning the formation, features and

the articles of the agreements, even though their function of security is similar. It is useful to begin by
mentioning the differences between these two agreements briefly[v].
For instance, since the obligations arising from suretyship agreements are accessory to the obligations arising
from the main agreement, the invalidity of the main agreement shall result in the invalidity of the suretyship
agreement. However, in cases where there is a guarantee agreement independent from the main agreement, the
creditor of the guarantee agreement may recourse to the guarantor even if the principal obligation becomes or
is deemed invalid.
Another difference between these two agreements is in the exceptions and objections arising from the main
agreement. In a suretyship agreement, the surety may exercise the exceptions and objections of the principal
debtor against the creditor, whereas the guarantor of a guarantee agreement may not exercise the exceptions
and objections of the principal debtor against the principal creditor.
The main difference with respect to these agreements is the form requirements. Suretyship agreements may be
concluded only by complying with important form requirements, whereas the validity of a guarantee
agreement does not require any special form[vi].
As seen, there are important differences between these two security agreements. Therefore, a determination of
which agreement the parties desire to sign is important. It is observed that parties often use the terms
suretyship agreement and guarantee agreement interchangeably, thus the real intentions of the parties
while signing the agreement must be determined. For instance, a 2001 decision of the General Assembly of the
Civil Chambers of the Court of Cassation concluded that an agreement referred to as a guarantee agreement by
the parties was actually a suretyship agreement, and the Court ruled that the agreement was invalid, since the
requirements of form were not respected[vii].

Criteria to be Considered
Certain criteria may be used for distinguishing these two types of agreements[viii]. The first criteria to be
taken into account are the expressions used by the parties. Despite the fact that the expressions of the parties
are not sufficient to determine the nature of agreement, it is apparent that these expressions are the starting
point for determining the nature of the legal relationship. As has been already indicated, the usage of these two
words in place of each other causes substantial problems. This circumstance is mostly observed in translations
made from foreign languages into Turkish. The English word guarantee is translated into Turkish both as
guarantee and suretyship. However, the nature of the agreement is not taken into consideration in the
course of translation. Therefore, the expressions used by the parties are important in determining the nature of
the agreement. Nonetheless, the clarity of the parties expressions does not remove the need for interpretation.

Other criteria, which can be used, to distinguish between these two agreements are the clauses stipulated in the
agreement. Some of the clauses stipulated in the agreement may indicate the presence of a guarantee
agreement, whereas some clauses may indicate the presence of a suretyship agreement. For instance, it may be
inferred that a waiver of exception aimed at proceeding against the principal debtor instead of the surety or the
exception of foreclosure or waiver of the right of recourse may indicate the presence of a suretyship
agreement, since the aforesaid exceptions are seen only in suretyship agreements; and it may be accepted that
the clauses on waiver of these rights can only be regarded as a suretyship agreement. Additionally, a clause
concerning the several and joint liability of both parties may result in the assessment of the security as a
suretyship. Further, a reference in the security agreement to the principal agreement from which the principal
obligation arises may indicate the presence of a suretyship agreement, since a suretyship agreement is an
accessory to the principal agreement, whereas a guarantee agreement is an agreement independent from the
principal agreement from which the principal obligation raises.
Furthermore, clauses regarding payment on first request, being bound by an unconditional and non-recourse
obligation or the non-existence of an objection right to the debt may result in the determination that the
agreement is a guarantee agreement.

Conclusion
As demonstrated, guarantee agreements and suretyship agreements are two different types of agreements
which can be easily mistaken for one another. However, it is important to discern between the two, and the
above-stated criteria may be used to do so. However, the criteria stated above are separately insufficient for the
determination of the nature of an agreement. Besides, each legal relationship has its unique conditions.
Therefore, each situation must be assessed on a case-by-case basis when determining if a security relationship
is a guarantee agreement or a suretyship agreement.

[i] Kocayusufpaaolu, Necip / Hatemi, Hseyin / Serozan, Rona / Arpaci, Abdulkadir, Borlar Hukuku, Genel
Blm, Istanbul 2008, p. 332. The author indicates that if the intentions of the parties are declared falsely, the
rule of falsa demonstratio non nocet shall be applied and the nature of the agreement will be determined
through an interpretation of the real intentions of the parties.
[ii] For critique of the article please see Kocayusufpaaolu/Hatemi/Serozan/Arpac, p. 332. According to the
author, the article in question has the assumption that the real intentions of the parties are known and it does

not
[ii] For critique of the article please see Kocayusufpaaolu/Hatemi/Serozan/Arpac, p. 332. According to the
author, the article in question has the assumption that the real intentions of the parties are known and it does
not regulate how the unknown intentions will be examined. It is indisputable that the authors critique applies
to Art. 19 of TCO, since the above article is the same as Article 18 of CO.
[iii] Even though it may be claimed that interpretation is not necessary if the intentions of the parties are
sufficiently clear (in claris non fit interpretatio), this view is justifiably criticized in the doctrine. Please see
Kocayusufpaaolu/Hatemi/Serozan/Arpac, p. 333. Even if the parties use clear expressions, the
determination of intentions, which are opposite to what has been expressed, can only be determined through
interpretation. Not applying the method of interpretation because of the clear expressions of the parties may
result in undesirable consequences. Therefore, even if the parties intentions are clearly expressed, determining
the real intention of the parties is important.
[iv] Barlas, Nami, Kefalet Hukukuna likin Baz Sorunlar/ Yargtay Uygulamas, Ticaret Hukuku ve Yargtay
Kararlar Sempozyumu, 2005, XXI, p. 56 vd.; Develiolu, Hseyin Murat: Kefalet Szlemesini Dzenleyen
Hkmler Inda Bamsz Garanti Szlemeleri, stanbul, 2009; Kocaman, Arif, B., Banka Teminat
Mektuplarnn Hukuki Nitelii zerine, Batider 1990, pp. 49 64; zen, Burak, Kefalet Szlemesi, stanbul
2012.
[v] For detailed explanations concerning the differences between suretyship and guarantee agreements and the
regulations adopted by the TCO, please see Asik Zibel, Berna, Guarantee and Suretyship Agreements, Erdem
Erdem Newsletter, September 2011,
http://www.erdem-erdem.com/newsletter.php?
katid=12110&id=14819&main_kat=14814&yil=2011
[vi] However, Article 603 of the Turkish Code of Obligations is reserved. Namely, pursuant to the aforesaid
article, in all security relationships which real persons are party to, including guarantee agreements, the
requirements of form set forth for the suretyship agreement shall be complied with.
[vii] Please see Yarg. HGK. 4.7.2001 Tarih E. 2001/19 534, K. 2001/583 (www.kazanci.com) For detailed
assessment of the decision please see Kocaman, Arif, B., Yargtay Hukuk Genel Kurulunun 4.7.2001 Tarih ve
E. 2001/19-534, K. 2001/583 Sayl Karar zerine Bir Deerlendirme Kredi Kart likisinde Bankaya Kar
Verilen Kiisel Teminatn Hukuki Nitelii: Garanti mi, Kefalet mi?, Ticaret Hukuku ve Yargtay Kararlar
Sempozyumu, 2003, C.XIX, p. 65 vd.;
[viii] For detailed information please see Develiolu, pp. 225-228.

Section 5. Distinction Between A Surety And A Guarantor

Description
This section is from the book "Popular Law Library Vol9 Bills And Notes, Guaranty And
Suretyship, Insurance, Bankruptcy", by Albert H. Putney. Also available from Amazon:Popular
Law-Dictionary.

Section 5. Distinction Between A Surety And A Guarantor

Although a surety and a guarantor are both parties who make an express agreement to bind
themselves for the performance of an act or the fulfillment of an obligation or duty of
another, the distinctions between the contract of the two persons, and the obligations
assumed under their contract, can be sharply made. A surety, as a general rule, is a party to
the original contract of the principal, he signs his name to the original agreement at the
same time the principal signs, and the consideration for the principal's contract is the
consideration for the agreement of the surety's. The surety is therefore bound on his
contract from the very beginning, and he is bound also to inform himself of the defaults of
the principal debtor, and he is not in any part relieved from his obligations under the
contract by the creditor's failure to inform him of the principal's default in the contract, for
which contract the surety has become the security for. A guarantor, on the other hand,
usually does not make his agreement to answer for the principal's debt or default,
contemporaneously with the principal or by the same agreement, but his obligation is
entered into subsequently to the making of the original agreement, and his agreement is not
the contract that the principal makes, and hence a new consideration is required to support

it. The contract of the principal's, not being the one the guarantor makes, he is not bound to
inform himself of default, or failure of principal to perform his contract. The creditor is also
under the obligation to inform the guarantor of the principal's default, not strictly in the
sense of being obliged to give notice immediately after demand on the day the obligation
matures, as in the case of an indorser, but if a failure to give noticematerially prejudices
the rights of the guarantor, the guarantor can claim a discharge on the obligation to the
extent of the injury suffered.2 The contract of the guarantor is not only collateral, but it is
secondary; the surety's contract is primary and direct.3
The guarantor is liable only after the default of the principal; the liability is established by
the default of the principal, and by showing performance of the conditions of the contract.4
But on discussing the distinctions between the surety and the guarantor in respect to the
liability assumed, we must remember that guaranties are of two kinds, the
conditional guaranty, and the absolute guaranty. In the former the guarantor is only liable
after the condition of the guarantor's contract is fulfilled. So, then, where A guarantees the
collectibility of a certain sum for another person, his obligation matures when the creditor
makes the showing that the debt is not collectible; this usually requires the exhausting of all
the legal remedies to collect, as by securing a judgment against the principal debtor, and
having execution issue on the judgment, together with the sheriff's return showing that the
execution cannot be made, because the principal has no goods or property, that may be sold
when levied on, to satisfy the execution. An absolute guaranty is one that arises where the
guarantor fixes the time to pay, as of some date certain; in this kind of guaranty it is not
necessary that the creditor first take steps against the principal to charge the guarantor, as,
for instance, where the guaranty is for the payment of a bond according to its terms,5 or a
guaranty for the payment of a promissory note at its maturity.6 It has also been held that an
absolute guarantor is not discharged by the creditor's delay in enforcing payment from the
principal.7 It may be said, further, that it makes little difference whether the promissor calls
himself a surety or guarantor, the terms of the agreement will control, in determining
whether it is to be considered a contract of a surety or of a guarantor.
2 Graff vs. Simms, 45 Ind., 262;
Harris vs. Newell, 42 Wis., 687. 3 Milroy vs. Quinn et al., 69 Ind..
406.
4 Atwood vs. Lester, 20 R. I., 660. 5 Roberts vs. Ridle, 79 Pa. St., 468. 6 Campbell vs. Baker,
46 Pa. St., 243.

Continue to:

prev: Section 4. The Surety

Table of Contents

next: Section 6. The Liability Of The Surety

What is the difference between a surety bond and a bank guarantee?

Surety bonds are typically conditional whereas bank guarantees are on demand. Only the
performance risk lies with the surety, where the bank has the financial risk on the construction
project.

Accounting wise, surety is accounted for as a liability like other insurance products whereas credit
risks in a bank by nature are accounted for on the asset side.

Although in many countries originally banks mainly issued bonds, the security provided by an
insurer has proven equally acceptable. This has enabled many enterprises to set up separate
lines of credit and bonds with surety or insurance companies. In doing so, they protect their lines
of credit with banks, which might otherwise be blocked at such time when this working capital was
needed. Banks usually prefer to issue so-called on demand bonds and must therefore treat
them as un-presented letters of credit.
Unlike traditional insurance, sureties do not undertake to spread risk but rather to pre-qualify and
rigorously select their principals.

What is a surety?
Surety bonds or guarantees secure the fulfilment of a contract or an obligation up to the limit of
the bond. They protect the beneficiary against acts or events which impair the underlying
obligations of the so called principal. Underlying obligations can either be negotiated or can
have a statutory (legal) character.

Surety bonds guarantee the performance of a variety of obligations, from construction or service
contracts, to licensing, to commercial undertakings. Almost any sale, service or compliance
agreement can be secured by a surety bond.
Bonds and guarantees are normally required under the terms of a construction or engineering
contract, or in accordance with mandatory legal requirements, to secure the obligations of the
principal debtor (generally known as the principal).

A surety bond provides the security to protect the creditor against the default or insolvency of the
principal up to the limit of the bond. For example, the failure of a contractor to complete a contract
in accordance with its terms and specifications or the failure of an enterprise to pay taxes or
customs duties to a government or department.

They play a vital part in domestic and international trade and in particular protect taxpayers
against the loss of public funds.

How does a surety bond protect the creditor?

A surety bond provides the security to protect the creditor against the default or insolvency of the principal
up to the limit of the bond. For example, the failure of a contractor to complete a contract in accordance
with its terms and specifications or the failure of an enterprise to pay taxes or customs duties to a
government or department.
They play a vital part in domestic and international trade and in particular protect taxpayers against the
loss of public funds.

How much will my surety bond cost?

There are no fixed rates. Each case is reviewed upon its own merits. The rate applicable will be
determined by reference to all the factors considered in the underwriting appraisal but primarily the
financial strength and the likely volume and nature of the bonds.

Guaranty vs. Surety - Old Common Law Distinction Makes Comeback

Date: 10/27/2010
Business Update 10_27_10

A recent Illinois Supreme Court case illustrates that old common law terms, although obscured by misuse
and disuse, may still have critical definitions which could have important implications, particularly for
creditors relying on personal guaranties. (JPMorgan Chase Bank, N.A. v. Earth Foods, Inc. Illinois
Supreme Court, No. 107682, October 21, 2010)
In 2001, JPMorgan Chase Bank extended a line of credit to Earth Foods, Inc. All three co-owners
personally guaranteed the loan. On April 3, 2003, one of the co-owners andpersonal guarantors, Leonard
DeFranco, sent the Bank a letter. The letter warned that Earth Foods was depleting the inventory which
served as collateral and demanded the Bank take action. Earth Foods stopped making payments to the
Bank in February 2004 and, on April 23, 2004, more than one year after Mr. DeFranco's warning, the
Bank sent a notice of default and demand for payment.
Of course, the Bank also sought to enforce the personal guaranties. But Mr. DeFranco fought back. He
claimed an affirmative defense under the Illinois Sureties Act (740 ILCS 155/1 (West 2000)). Under the
Sureties Act, a surety is given the right to require a creditor to take action when the principal (here, Earth
Foods) "is likely to become insolvent." If the creditor fails to do so within a reasonable time, the surety can
be discharged. Mr. DeFranco argued that he was discharged by the protections in the Sureties Act.
The circuit/trial court disagreed with Mr. DeFranco. It concluded that Mr. DeFranco was a guarantor and
not a surety. Therefore, the Sureties Act was inapplicable. The circuit court granted summary judgment to
the Bank. The lower appellate court took a different approach. It concluded that "surety" under the
Sureties Act included both a guarantor and a surety. It remanded the case back to the circuit court.
However, in the meantime, the Illinois Supreme Court granted the Bank's petition to appeal.
In its opinion, the Illinois Supreme Court spent considerable time discussing the historic distinction
between sureties and guarantors, although it acknowledged that current usage has blurred the distinction.

But the Court found that, in spite of current usage, it was required to recognize the distinction. In doing so,
the Court went way back in time.
The Court noted that the Sureties Act is descended from a statute passed in 1819, with different language
but the same effect. The Sureties Act language has been modified and updated, most recently in 1985,
but the policy and purpose never changed.
Citing treatises and cases from the 19th century and early 20th century, the Court noted the historic
distinction between a guarantor and a surety. As one example, the Court quoted Corpus Juris: "A surety is
an insurer of the debt or obligation, while a guarantor is an insurer of the ability or solvency of the
principal." (28 C.J. Sections 4 and 5 at 890-891 (1922)). Similarly, the Court cited a 1934 Illinois case:
"The true distinction seems to be that a surety is in the first instance answerable for the debt for which he
makes himself responsible, while a guarantor is only liable where default is made by the party whose
undertaking is guaranteed." (Vermont Marble Co. v. Bayne, 356 Ill. 127 (1934)).
According to the Court (citing a suretyship treatise), at common law, the surety had no right to require the
creditor to take action against the principal. So the surety was not discharged, even if the creditor
neglected or failed to take action. As a result, many states, including Illinois, passed statutes like the
Sureties Act to give the surety protections unavailable at common law.
So, is Mr. DeFranco a surety and able to use the Sureties Act to avoid his "personal guaranty?" Or is Mr.
DeFranco a guarantor with primary liability? For a business lawyer, this is where the Court's opinion
becomes problematic.
The Court remanded the case for further proceedings to give Mr. DeFranco an opportunity to develop his
argument as to whether he was a surety or a guarantor. The Court even suggested parol evidence may
be necessary for this purpose. "Thus, the more general meaning of the word "guarantee" often used in
business contexts may require courts to consider evidence outside the language used in the document to
determine whether the parties intended to create a guaranty or surety."
The Court indicated that the written agreement signed by Mr. DeFranco referred to a "guarantee." But, in
other respects, the Court's opinion left out some facts and background that would have been helpful to
business lawyers. In a commercial context, guaranties (in the generic sense) generally are self-contained
documents with an integration clause. The Court does not indicate whether the guaranty at issue in this
case contained an integration clause.
Moreover, most standard form guaranties contain waivers by the guarantor of the type of conduct or nonaction allegedly committed by the Bank. The Court's opinion is silent on this also. In most guaranties, the
guarantor's obligation is unconditional, primary and direct, and not dependent on the principal's
insolvency or inability to pay, but there is no indication if this provision was in the guaranty agreement at
issue.
As we have seen with the recent allegations of improper mortgage documentation by banks, it is not
inconceivable that the Bank's form of guarantee was not well drafted or failed to contain some standard
commercial terms. But this cannot be assumed.

So an attorney representing a creditor must now be concerned about the potential application of the
Sureties Act, regardless of the term used in the document and perhaps even regardless of explicit waivers
in the document. As the case illustrates, common law terms can still have viability with real effects in
commercial transactions.
For more information about this or any other corporate law topic, please contact Stephen Proctor, Chair of
the Business Group, at 847.734.8811 or via email atsproctor@masudafunai.com.

You Say Tomato, I Say Tomahto: Court Holds Illinois Sureties Act Applicable to
Guarantors
By Kenneth J. Ashman & Bardia Fard
The distinction between a surety and a guarantor is one which may be lost upon
many practitioners. According to Blacks Law Dictionary, a surety is defined as [a]
person who is primarily liable for the payment of anothers debt or the performance of
anothers obligation. BLACKS LAW DICTIONARY 1482 (8th ed. 2004) (emphasis
added). In contrast, [w]hile a suretys liability begins with that of the principal, a
guarantors liability does not begin until the principal debtor is in default. Id. at 724.
The distinction may be summarized as follows: a surety is primarily liable on the
underlying obligation, while a guarantor is secondarily liable.
In the strictest sense, then, a surety is a wholly different creature than a guarantor
right? Not according to a recent Illinois Appellate Court decision in JP Morgan Chase
Bank, N.A. v. Earth Foods, Inc., 386 Ill.App.3d 316, 898 N.E.2d 718 (2nd Dist.
2008), appeal allowed, 231 Ill.2d 632 (Ill. Jan. 28, 2009), which held that the term
surety, as used in the Illinois Sureties Act, 745 ILCS 155/1, also encompasses a
guarantor. The holding in Earth Foods makes available to a guarantor those defenses
previously only available to a surety under the Sureties Act, and the decision may have
repercussions for similar statutes across the United States.
In Earth Foods, the defendant Earth Foods, Inc. (Earth Foods) was the primary debtor
on a line of credit issued by JP Morgan Chase Bank, N.A. (JP Morgan), which was
personally guaranteed by Earth Foods three co-owners, which included defendant
Leonard S. DeFranco (DeFranco). Earth Foods, 898 N.E.2d at 720. Before JP Morgan
sent Earth Foods a notice of default, DeFranco sent JP Morgan a letter alerting it that
Earth Foods was dissipating its inventory, which served as collateral to the line of credit,
and further demanded that JP Morgan institute an action against Earth Foods. Id. After
Earth Foods continued failure to make payment on the line of credit, JP Morgan filed
suit against Earth Foods and its three co-owners/guarantors, including DeFranco. Id.
DeFranco invoked Section 1 of the Sureties Act, arguing that his notification to JP
Morgan of Earth Foods near-insolvency discharged his obligation as a guarantor. Id. at
721. Section 1 of the Sureties Act provides as follows:

When any person is bound, in writing, as surety for another for the payment of money,
or the performance of any other contract, apprehends that his principal is likely to
become insolvent or to remove himself from the state, without discharging the contract,
if a right of action has accrued on the contract, he may, in writing, require the creditor to
sue forthwith upon the same; and unless such creditor, within a reasonable time and
with due diligence, commences an action thereon, and prosecutes the same to final
judgment and proceeds with the enforcement thereof, the surety shall be discharged;
but such discharge shall not in any case affect the rights of the creditor against the
principal debtor. 740 ILCS 155/1.1 The trial court rejected DeFrancos argument, and
entered summary judgment in favor of JP Morgan. Earth Foods, 898 N.E.2d at 721.
On appeal, DeFranco argued that the even though the contract identified him as a
guarantor, rather than a surety, the trial court erred when it rejected the application
of the Sureties Act and entered summary judgment in favor of JP Morgan. Id. The crux
of DeFrancos argument was that the term surety should be construed to include
guarantors. Id. JP Morgan countered that the plain text of the Sureties Act made clear
that its provisions were unavailable to DeFranco, as a guarantor. Id.
In holding that guarantors were included in the term surety, the appellate court
undertook an analysis of the popularly understood meaning of the terms suretyship
and guaranty. Id. Relying on Illinois jurisprudence, sister states jurisprudence, and
several secondary sources, including the Restatement (Third) of Suretyship and
Guaranty, the court noted that
the term surety has more than one popularly understood meaning: the word is
sometimes used to refer to any situation in which a person agrees to be held liable for
the debt of another, whether the liability is primary as a surety or secondary as a
guaranty, and it is sometimes used to refer strictly to a surety who is primarily liable.
Id. at 723. The court further opined that the terms guarantor and surety are
unusually intertwined in legal parlance and that the distinctions between them are
arcane and often ignored. Id. at 724. Given the interchangeable use of the terms,
coupled with the remedial purposes behind the Sureties Actto compel diligence by a
creditor to make certain a surety is protected against lossthe court held that the
statute applied with equal force to guarantors as it did to sureties. Id. (citation omitted).
Accordingly, the court found that the trial court erred in granting JP Morgans motion
for summary judgment on the basis that DeFranco could not invoke a defense provided
by the Sureties Act. Id. at 726.
The holding in Earth Foods is the first of its kind in Illinois, and it departs dramatically
from the strict definitions ascribed to surety and guarantor. Since the appellate
courts decision relied in part on interpretations from sister jurisdictions, the decision
has potential implications nationally. Because of the importance of the precedent set
by Earth Foods, on January 28, 2009, the Illinois Supreme Court accepted an appeal by

JP Morgan, which is still pending adjudication. Assuming the high court affirms the
appellate courts holding, guarantors will have a new defense to creditors collection
efforts, where the strictures of the Sureties Act are met. Stay tuned for updates as the
Illinois Supreme Court weighs in with its definitive ruling on the question.
Kenneth J. Ashman is a principal of Ashman Law Offices, LLC (ALO), a business law
and litigation boutique with offices in Chicago, Lincolnshire (Illinois), and New York.
He attended both Boston University School of Law and New York University School of
Law, and prior to founding his own firm in 1997, served as an associate with New
Yorks Weil, Gotshal & Manges, LLP and LeBoeuf, Lamb, Greene & MacRae, LLP (now
Dewey & LeBoeuf, LLP). He served as a judicial law clerk to the Honorable Frederic
Block, United States District Judge for the Eastern District of New York, who he now
proudly calls a client. Mr. Ashman is a frequent publisher and speaker on a variety of
areas of business law, and is not only active in the ABA, but also holds leadership
positions in a number of state and local bar associations. Bardia Fard was formerly
associated with ALO. Mr. Ashmans firm prides itself on competing with and providing
the same quality representation as the largest law firms, but, through lean staffing,
the latest in law office technology, and flexible billing approaches, at greater efficiency
and reduced cost. For reprints of other publications authored or coauthored by Mr.
Ashman, please visithttp://www.AshmanLawOffices.com or the firms blog
athttp://www.Ashman-Law.com.
Note

1. Section 3 of the Sureties Act provides another defense 1 for a surety, stating as follows:
Whenever the principal maker of any note, bond, bill or other written instrument dies, if
the creditor does not, within 6 months after the entry of the original order directing
issuance of letters of office, present the same to the representative or the proper court
for allowance, the sureties thereon shall be released from the payment thereof to the
extent that the same might have been collected of such estate if presented in proper
time; but this Section shall not be construed to prevent the holder of any such
instrument from proceeding against the sureties within such 6 months. 740 ILCS 155/3.

THE CONTRACT OF GUARANTEE IN SOUTH AFRICAN LAW

In any financing transaction banks and other lenders seek to protect their financial exposure by taking some form of
security.

THE CONTRACT OF GUARANTEE IN SOUTH AFRICAN LAW

By Sanguita Popatlal

In any financing transaction banks and other lenders seek to protect their financial exposure by taking
some form of security. A guarantee by a third party, often the holding company of the borrower or a bank,
is used if the banks are comfortable with the creditworthiness of such third party. A contract of guarantee
has been defined to mean a collateral engagement to answer for the debt, default or miscarriage of
another person. It is thought to impose an absolute liability on the guarantor; if the guarantor fails to
make good the guarantee, he will be liable for breach of contract.
Contracts of guarantee create primary obligations which are not dependent on the existence of any other
debt or agreement. The contract of guarantee can be distinguished from the contract of suretyship, which
create an accessory obligation. An accessory obligation is an obligation that is dependant on the
existence or coming into existence of a valid and effective principal obligation. There can be no
accessory obligation when the principal obligation to which it relates to is a nullity or if the principal
obligation has been extinguished, for example, by performance or payment. Therefore, in a contract of
suretyship there must be an underlying valid principal obligation between someone other than the surety
as debtor (the principal debtor) and the creditor that the surety binds himself to.
The contract of surety is of Roman Law import. A surety is one who takes upon himself the obligation of
another, that other still being liable. Caney maintains that the surety firstly undertakes to the creditor that
the principal debtor, who remains bound, will perform his obligation, and secondly that insofar as the
principal debtor fails to do so, the surety will perform it or failing that indemnify the creditor. This
indemnity usually takes place by the payment of money to the creditor. Caney distinguishes suretyship
from guarantee by stating that where a person has done no more than guarantee or undertake to pay in
the event of the debtor not doing so, this is an original undertaking made on the condition of non-payment
by the debtor. Therefore, in a guarantee the guarantor does not undertake that the principal debtor will
perform his obligations and only failing that will the guarantor be liable.
Joubert supports the view that contracts of guarantee create primary obligations which are not dependent
on the existence of any other debt. Joubert is of the opinion that a partys obligation will be termed as a
primary one if his liability does not depend on the breach of contract of another person. On Jouberts
view of the contract of guarantee, if a guarantee is made conditional on the default or breach of contract
of the principal debtor is not a guarantee in the strict sense of the definition since it is dependent on the
existence of another debt. In such a case, the undertaking to pay by the guarantor cannot come into
existence until and unless the principal debtor has breached the contract with the creditor in some
manner. The guarantors liability would also be limited in those circumstances to the extent of the liability
of the principal debtor in terms of the principal obligation.
List v Jungers 1979 (3) SA 106 (A) remains the precedent in the distinction between the contracts of
guarantee and suretyship. The Appellate Division held that the words guarantee and warrant have a
variety of meanings and their precise meaning must be obtained from the particular context in which they

are used. It was held that guarantee may in a particular context be used in connection with the
accessory obligation of a surety but in other cases the parties may have intended that the guarantor
undertake a primary obligation to pay the debt of the principal debtor.
In Carrim v Omar 2001 (4) SA 691 (W), the Honourable Judge Stegmann stated that the legal issue to be
decided in the appeal was whether the defendant validly undertook the enforceable primary obligations of
an indemnifier or guarantor or whether the defendant merely purported to undertake the accessory
obligations of a surety for the indebtedness of the principal debtor (the Islamic Bank Ltd) to the
plaintiff. Judge Stegmann disagreed with Caneys proposition that an essential element of suretyship is
that the surety must undertake that the debtor will perform his obligation to the creditor.
There are times when the wording of the guarantee will be such that it is an unconditional undertaking to
bind the guarantor as co-principal debtor. If the wording is such, then it is submitted that such a
guarantee is not a suretyship and therefore, does not require the creditor to first try and obtain
performance from the debtor, he can demand payment or performance from the guarantor first.
In terms of common law, a surety is discharged if the principal obligation is extinguished, for example, due
to performance by the principal debtor or to impossibility of performance or invalidity of the debt. A
suretyship may also be terminated if the accessory obligation between him and the creditor is
extinguished even though the principal obligation between the principal debtor and the creditor is still in
force, for example if the surety performs the accessory obligation or in the event of irregular conduct of
the creditor that prejudices the interests of the surety.
A guarantee, on the other hand, due to the fact that it is a principal obligation, can only be discharged if
there is performance of the principal obligation or payment on the part of the guarantor.
In conclusion, the contract of guarantee does not have a defined legal meaning in South African law. If a
guarantee is given conditional upon the breach of contract, or default of the principal debtor, such a
guarantee is accessory in nature and therefore, ranks as a suretyship. It is submitted that this is not a
true guarantee. However, if a guarantee takes the form of an absolute and unconditional promise it
cannot be a suretyship and is principal in nature. The practical implication of a guarantee drafted so that
it creates a primary obligation, is that the guarantor does not have the same defences available to him as
that of a surety, the main one being that of excursion, that the creditor should first try to obtain
performance from the principal debtor and only insofar as he fails to do so will the guarantor be liable.