What is a Suretyship?
As a business owner, you have probably signed suretyship for your business more than once. It is almost impossible these days for a company or a CC to get a loan, an overdraft or a line of credit without the owner signing surety.
What does it really mean to sign a suretyship, and what are the personal risks for you in doing so? This article explains the meaning of suretyship in simple terms, and highlights the risks involved.
Dave is the sole shareholder of Craft Beer Co. (Pty) Ltd (“Craft Beer”). Dave chose to house his business in a company because he did not want his personal assets (such as his house) ever to be sold to pay the debts of his business. He wanted to enjoy the limited liability that a company allows for. In law, the debts of the company are NOT the debts of the shareholder.
Craft Beer wants to purchase glass bottles from Clear Glass Bottle Co. (“Clear Glass”) with delivery on a weekly basis, but payment on 90 days, in other words: Craft Beer wants to buy the bottles on credit. Clear Glass is afraid that if it sells bottles on credit, and Craft Beer goes insolvent, Clear Glass will never receive full payment. Clear Glass therefore requires Dave to sign surety for the debts of Craft Beer.
By signing surety, Dave is giving a promise to Clear Glass that, if Craft Beer fails to pay what it owes, Dave himself will pay what Craft Beer owes. Dave is agreeing that when it comes to the debts of Craft Beer to Clear Glass, limited liability will not apply. Dave’s personal assets (his savings, his house, his car…) could be used to pay Craft Beer’s outstanding debts to Clear Glass.
Practical Consequences
A few months go by, and Craft Beer receives a number of deliveries of bottles. It experiences cash flow problems and falls behind on payment to Clear Glass. After 11 months, it owes Clear Glass around R800,000 for bottles delivered, plus interest on that outstanding amount.
Clear Glass has sent two lawyer’s letters to Craft Beer, demanding payment. Now Clear Glass instructs its attorney to address a letter to Dave, demanding the outstanding money, plus interest and costs.
Assuming the suretyship that Dave signed is valid, and depending on its specific terms, Dave is now legally obliged to pay Clear Glass the following:
- the total amount owing for bottles delivered but unpaid for;
- interest on the outstanding amount; and
- the costs of Clear Glass’ attorneys in trying to recover what is owing.
Let’s say Clear Glass is demanding R870,000. Dave has about R700,000 in savings and policies. He also owns a car and an apartment, but the apartment is mortgaged to the bank. Dave has no choice but to sell his car and receives R200,000 for it. He also draws out his savings and cashes in his policies, freeing up R700,000 in cash.
With this money he pays Craft Beer’s R870,000 debt to Clear Glass, and is left with R30,000 and his bonded apartment. This is the consequence of Dave signing suretyship for Craft Beer.
Things to look out for
The basic principle of suretyship is that, under common law, a suretyship creates a contingent obligation, because the obligation of Dave to pay is contingent upon Craft Beer owing a debt in the first place. The chief significance of this is that, if Dave can show that Craft Beer does not in fact owe Clear Glass any money, then Clear Glass cannot recover anything from Dave under the suretyship.
Suretyship documents are always drawn up heavily in favour of the creditor. Very few creditors will be prepared to negotiate on the terms described below, but it’s important to understand them, and you can always try! By the same token, if you are the creditor requesting someone else to sign suretyship, make sure these terms appear in the document.
A suretyship will frequently start with the following: “I, Dave, hereby bind myself as surety… jointly and severally, for all debts at any time owed to Clear Glass by Craft Beer”. To be jointly and severally liable with another means that the creditor can pursue either one of you for the debt, or it can recover some of the debt from you and some from the other, whichever the creditor chooses and in whatever proportions it chooses – not necessarily 50/50.
A number of defences are available to a surety under common law. It is usual for suretyship documents to exclude all those defences, however, so that the surety cannot rely on them.
You will likely see a clause along the following lines: “I renounce the benefits of no value received; non numeratae pecuniae; non causa debiti; errore calculi; revision of accounts; beneficium ordinis seu excussionis and divisionis; beneficium divisionis; cession of action; and de duobus vel pluribus reis debendi, the full meaning and effect of which has been explained to me, and which I know and understand”.
Dave (as surety) has the right to have the meaning of that clause properly explained to him before he signs. The creditor’s attorney should explain each of those phrases, or Dave can ask his own attorney what they mean.
The suretyship document will almost always create what is known as a continuing covering security. This means that the suretyship will remain in force for as long as the creditor chooses, and if Craft Beer incurs debts to Clear Glass from time to time over the years, Dave will be liable for those debts under the suretyship.
What is important to look out for is that the suretyship document limits the scope of Dave’s liability to liability for debts to Clear Glass that arise out of the specific bottle supply agreement only.
It could happen that Craft Beer owes money to Clear Glass for something totally unrelated to the bottle supply agreement. For example, Craft Beer uses Clear Glass’s trademark on its website without permission, and Clear Glass wins a damages claim. If Dave has limited the scope of his liability under the suretyship document to amounts arising only under the bottle supply agreement, he will not be liable under the suretyship for the trademark damages claim.
Suretyship documents will typically contain a clause allowing the creditor (Clear Glass) to cede and assign its rights under the suretyship to a third party. Clear Glass may wish to sell its business, including its book debts. In that scenario, Clear Glass would transfer not only the book debts it has against Craft Beer, but also its rights under the suretyship, to the buyer of the business. Dave’s liability under the suretyship would henceforth be to the buyer of the business rather than to Clear Glass.
Most suretyship documents will contain a clause stating that the obligations contained in the suretyship document are “binding on my estates, heirs, executors, administrators, trustees or permitted assigns as fully and effectually as if they had signed this suretyship in the first instance”. This means that even if the surety (Dave) passes away, Clear Glass will still be able to claim for Craft Beer’s debts from Dave’s deceased estate.
Finally, if you are the creditor requesting that someone sign surety, be sure to ask the surety whether they are married in or out of community of property. If the individual signing surety is married in community of property, their spouse must sign the suretyship document as well. If their spouse does not sign the suretyship document, only 50% of the joint spousal estate is available to settle the creditor’s claims. The other 50% of the joint spousal estate (the spouse’s half) cannot be touched.
The reality is…
Most business people have little choice but to sign surety for their business. Few will feel it’s worthwhile having their attorney review the document, because creditors will generally not negotiate the terms. This is broadly true, but what IS important is for creditors to ensure the suretyship documents that they have adequately protect their interests, and do not contain loopholes for the surety to wriggle out of.