Legal nature of guarantee and surety agreements differ in important ways

Dünya Executive - - BUSINESS BY LAW - UMUT KOLCUOGLU MANAGING PARTNER ATTORNEYS AT LAW [email protected]

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.

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