What you need to know about suretyship Many small businesses start with a lack of tangible security against which they can borrow money from banks or apply for credit from suppliers. One way in which creditors protect themselves against defaulting custome
asuretyshipis, essentially, an undertaking by a person – the surety – to pay a creditor should a debtor default, according to Brian Jennings and Sanushka Chetty, both senior associates in ENSafrica’s corporate commercial department. As such, it is a form of security given by a third party to secure the debts of a debtor in favour of a creditor. There is usually a relationship between the debtor and surety, e.g. they might be a family member or there may be some other relationship of trust between them, according to Jennings and Chetty.
Potential sureties should ensure that they understand the impact that different suretyship provisions could have and read the suretyship documentation carefully in order to avoid nasty surprises in future should the debtor – whether an individual or the small business – not be able to repay monies owed to creditors, according to them.
“If one was acting for a surety, one would want to consider limiting the surety’s liability under the suretyship to a fixed amount,” they say. A potential surety should also be vigilant as to whether a creditor excludes the common-law benefit of excussion in the suretyship, Jennings and Chetty say. Under a typical suretyship, the creditor would be obliged to sue the debtor first to recover their loss, before the creditor is entitled to sue the surety, and then only for the balance of the creditor’s loss, they explain. This is called excussion.
“Because this process is cumbersome and time-consuming, creditors often exclude the benefit of excussion in the suretyship,” they explain. “By doing so, the creditor is entitled to sue the surety directly for the entire amount of the creditor’s loss.”
It is then up to the surety to recover the amount he or she paid to the creditor from the debtor, they say.
WHAT ARE THE PITFALLS OF SURETYSHIP?
The major pitfall is that the small-business owner’s personal assets, e.g. their home, would no longer be protected by the separate legal personalities that exist between the owner and the small business. A creditor would be entitled to claim against the small-business owner’s personal estate for the entire amount of the underlying debt.
If the debtor or the surety’s assets are not enough to cover the debt owed to the creditor, then the debtor and/or the surety would face insolvency proceedings.
There are other non-legal consequences of being required to make payment under a suretyship, including possible adverse credit ratings and increased cost of doing business.
Potential sureties should ensure that they understand the impact that different suretyships provisions could have and read the suretyship documentation carefully in order to avoid nasty surprises in future.
Brian Jennings Senior associate at
Sanushka Chetty Senior associate at