Legal nature of guarantee and surety agreements differ in important ways
Our recent experience in disputes governed by Turkish law shows that parties should be very diligent while drafting guarantee agreements. Omissions that seem very simple may lead to significant problems in the later stages, particularly in determining the legal nature of these agreements, whereby confusion arises about whether the agreement is a guarantee or a surety.
Guarantee agreements and surety agreements are both security agreements under which the guarantor assumes the risk of non-performance of an obligation by a third party or debtor. Yet there are substantial differences between these two legal concepts.
The most distinct difference between a surety agreement and a guarantee agreement is that a surety agreement is of secondary nature, while a guarantee agreement imposes a primary and independent obligation on the guarantor. This means that if the debtor’s obligation is or becomes invalid, the surety agreement terminates, but the guarantee agreement remains effective regardless of whether or not the guaranteed obligation.
Furthermore, the secondary nature of the surety agreements enables the guarantor to benefit from defenses that the original debtor would put forward, but this is not possible under the guarantee agreement.
For instance, under a surety agreement, the guarantor can claim that the time bar for the debtor’s obligation has expired, but under the guarantee agreement it cannot ben- efit from the debtor’s defenses as its guarantee undertaking is independent from the debtor’s obligation.
Finally, under the surety agreement, the guarantor subrogates the debtor’s rights after fulfilling its obligations towards the beneficiary whereas under the guarantee agreement, the guarantor cannot have a recourse to the debtor unless the guarantor and the debtor have reached an agreement to this effect.
The Turkish Code of Obligations provides detailed provisions on the surety agreement by governing its validity conditions, types and the parties’ rights and obligations, but it does not govern the guarantee agreements in detail. For this reason, rules applied to guarantee agreements are determined by doctrine and court precedent.
Although guarantee and surety are two different types of agreements, they often are confused for one another. If the parties’ real intention is not clear from the wording of the security agreement, courts tend to interpret the relevant security agreement as a sure- ty agreement, which provides more favorable provisions for the guarantor compared to a guarantee agreement.
In addition, given that the surety agreements may be concluded only by complying with important form requirements, if the court concludes that the agreement referred to as a guarantee agreement is actually a surety agreement, it may also rule that the agreement is invalid because the form requirements are not met.
A guarantee agreement should be drafted with the utmost attention in order to reflect the parties’ real intentions and to avoid the agreement becoming invalid. Based on the jurisprudence of the Court of Appeals, as well as Turkish doctrine, the following points should be considered while drafting a guarantee agreement.
The wording used by the parties should explicitly, without any doubt, reflect that it is a guarantee agreement that has the character of “guarantee of performance by a third party” under Article 128 of the Code of Obligations and that it does not refer to the “surety”. The agreement should state that the guarantor’s commitment is entirely independent from validity and enforceability of the debtor’s obligation towards the beneficiary.
The agreement should also explicitly state each obligation guaranteed towards the beneficiary. For instance, the guarantor may guarantee only the performance of the principal obligation or the punctual performance of ancillary remedies granted by the debtor under the original agreement as well, e.g., penalties and interest payments.
Under the agreement, the guarantor should know that it is obligated to fulfill its guarantee undertaking towards the beneficiary upon debtor’s non-performance of its obligation, without being subject to any condition, including without the need for the beneficiary to pursue the debtor first.
Under the Turkish Commercial Code, the security arrangements executed by an individual are subject to certain form requirements. This requirement should be taken into consideration if and when the guarantor is an individual.
Although surety agreements and guarantee agreements have the same function, they have different legal characteristics, which may result in a different security regime for the beneficiary. To avoid significant problems in the future, these agreements should be carefully drafted by taking into consideration the distinctive legal nature of both concepts.