SECURITY DOCUMENTATION  IN COMMERCIAL TRANSACTIONS

WHY ASK FOR A GUARANTEE?

 

-         Common form of security used in the commercial world.

-         In use from ancient times.

-         To hold somebody else responsible for a debt.

 

 

1.         NATURE OF A GUARANTEE

 

            A guarantee is a collateral or subsidiary contract by which the promisor undertakes to answerable to the promisee for the debt, default or miscarriage of another person whose primary liability to the promisee must exist or be contemplated. A guarantee therefore is a promise by one person (surety or guarantor) to answer for the default of another (the principal debtor) to a third person (creditor). See s. 79 Contracts Act, 1950.

 

            Under Malaysian law a guarantee can be either oral or in writing. In practice it is almost always in writing.

 

2.         TYPES OF GUARANTEES

 

2.1       Personal Guarantees. (Note: Partners cannot guarantee the debt of the partnership nor can a sole proprietor act as a guarantor for his own debts.)

 

2.2.            Director’s Guarante

2.3.            Corporate Guarantee

2.4.            Performance Bond/Bank Guarantee: Under a performance bond a 3^rd person (bank/insurance firm) who is the surety undertakes to pay a certain sum to the employer (creditor) in the event that the contractor (the principal debtor) fails to fulfill his obligations under the contract. See Fasda Heights S.B. v. Soon Ee Sing Construction S.B.& Anor.[ 1999] 4MLJ 199; Esso Petroleum Malaysia Inc. v. Kago Petroleum Sdn. Bhd.[1995] 1 AMR 189 (FC)

 

2.5.Comfort Letters- Comfort letters are used in the context of parent-subsidiary relationships. Comfort letters may or may not be binding depending on the way it is drafted. In Kleinsworth Benson Ltd .v Malaysia Mining Corp Bhd. [1989] 1All ER 785, a comfort letter was issued by the Ds to P. ”It is our policy to ensure that the business of MMC Metals Ltd is at all times in a position to meet its liabilities to you under the above arrangements.” The court held that it was merely a statement of present fact and was not binding. But in Banque Brussels Lambert SA v. Australia National Industries Ltd [1989] (an unreported decision) the comfort letter was held

to create  a binding obligation.

 

 

3.         NATURE OF AN INDEMNITY

 

            A contract of indemnity is covered by s. 77 of the C.A.1950 which states as follows: A contract by which one party (the promisee) promises to save the other (the creditor) from loss caused to him by the conduct of the promisor himself, or by the conduct of any other person, is called a “contract of indemnity.” A contract of indemnity is a contract by which one party agrees to make good a loss suffered by the other. In the case of a contract of Indemnity, the indemnity holder becomes primarily responsible for the debt of another. Thus in a contract of indemnity, “the promisor undertakes an original and independent obligation to indemnify, as distinct from a contract of guarantee which is a collateral contract by which the promisor undertakes to answer for the default of another person who is to be primarily liable to the promisee” (Yeoman Credit Ltd v. Latter [1961] 2 All ER294)

 

            In Malaysia most guarantees though labeled as Guarantees are in fact contracts of indemnity because of the inclusion of the principal debtors clause.

 

4.         COURTS ARE NOT BOUND BY THE LABELS USED BY THE PARTIES

           

            Generally the courts are not bound by the labels that parties affix to a document. Instead the court will look into the document as a whole and consider the intentions of the parties in construing a document. This was the stand taken in Sia Siew Hong & Ors v.Lim Gin Chian & Anor [1996] 3 AMR 3651. In this case the appellants who were directors and shareholders of STL & sons Bhd wanted to obtain a loan from Interfinance Bhd (IB). The respondents agreed that their land be charged  to IB to enable the company to obtain the loan. In consideration of the respondents providing the land, the appellants agreed to provide a “guarantee” to secure the due performance by them of the terms of the loan agreement. The appellants defaulted on the loan and the land was sold by a public auction. IB then demanded from the respondents the balance due. The respondents commenced a suit against the appellants for RM250,000.00 based on the guarantee.

 

One of the issues was whether the document was a guarantee or indemnity. The Court of Appeal held that it was an indemnity for the following reasons:

1.   There was no obligation upon the respondents to make a formal demand of the appellants of the  sum in question.

2.   The deeming provision relating to the principal debtor clause imposes upon the appellants the principal obligation of a principal debtor and not merely a secondary obligation of a surety.

3.      The aim of the transaction as a whole intended the appellants to assume the primary obligation to indemnify the respondents.

4.      The existence of the clause “This guarantee may be enforced by either of you or both at any time” points to the appellants agreeing to undertake an original liability. 

See also Ling Sing Huat & Ors v.Kontiki Trading Pte Ltd. [1998] 4 MLJ 80

 

 

5.         THE PRINCIPAL DEBTOR CLAUSE

           

The principal debtor is the person primarily liable to the creditor for the debt, default or miscarriage answered for by the surety.

 

Documents of guarantee used by banks and large trading corporations will contain a clause stating expressly that the guarantor’s liability “shall be that of a principal debtor” or that the guarantor or surety will “guarantee as principal debtor and not merely as surety.”

In Bank Bumiputra Malaysia Bhd. v. Perbadanan Kemajuan Negeri Perak [1989] 1 MLJ 502 there was a clause in the following terms:

“As a separate and independent stipulation I/we agree that all sums of money not recoverable from me/us on the footing of a guarantee whether by reason of any legal limitation disability or incapacity on or of the borrower or any other fact or circumstances and whether known to you or not shall nevertheless be recoverable from me/us as a principal debtor or debtors in respect thereof and shall be repaid by me/us seven days after demand in writing made by you or on your behalf.”

The effect of such a clause is that the guarantor’s liability is neither collateral nor subsidiary. The guarantor has assumed the primary liability of the principal debtor and is now answerable for the debt.( See also Malaysian International Merchant Bankers Bhd. v. G & C Securities Sdn. Bhd. [1988] 2 MLJ 41.)

 

6.         EFFECT OF A CONCLUSIVE EVIDENCE CLAUSE

 

            Where the guarantee contains a “conclusive evidence clause” the courts have consistently held that the guarantor is liable for the amount stated and claimed by the creditor, unless thee is evidence of fraud or manifest error. In Goodyesr Malaysia Bhd. v. Tan kok Hai & 2 Ors[1993] 2 AMR 495 there was a clause in the guarantee which was in the following terms:

“A statement of account in writing showing the indebtedness and liability of the purchaser to you duly certified by your auditors shall be binding and conclusive against us as guarantors ..” Mohd.Hishamuddin JC held that such a statement of account “ is binding unless there is manifest error.”

 

 

 

7.         RIGHTS OF AN INDEMNITY-HOLDER WHEN SUED. (See s.78 CA,1950)

 

In law an action on a contract of indemnity does not normally arise until the promisee has paid the creditor’s claim. Where he has paid, the amount so paid, constitutes a debt due to him from the promisor which he may recover with interest in an action. Under s.78 CA 1950, the promisee is entitled to recover from the promisor:

-           all damages which he may be compelled to pay in any suit;

-           all costs which he may be compelled to pay in any such suit; and

-           all sums which he may have paid under the terms of any compromise.

.

 

 

 

 

8.         ESSENTIALS OF A GUARANTEE

 

Since a guarantee is a contract the essentials of a contract must be complied with. These essentials are as follows:

 

a)      Capacity of Parties- The parties must have the legal capacity to enter into a contract.In the case of individuals, they must be of the age of majority. In  Government of Malaysia v. Gurcharan Singh & Ors [1971] 1MLJ 211 the government sued D1 as the promisor and D2 and D3 as sureties for breach of agreement entered into by them with the Plaintiff for providing a course of training at a Teachers’ Training College. At the time of the contract, D1 was still a minor. The defendants contended that the contract with D1 was void and consequently the guarantee was also void. Chang Min Tat, J dismissed the government’s claim against the guarantors. Immediately after this case the Government amended the Contracts Act by way of Act A329  to make provisions for scholarship agreements.

 

b)      Consideration-

There must be some form of consideration in order to make a guarantee legal. Consideration is usually some benefit obtained by a party top a contract. Money paid is good consideration. In Malaysia there have been challenges to guarantees executed by the guarantors on the grounds that the consideration was past consideration i.e. the loan was disbursed before the guarantee was executed. But such arguments have been rejected by the Courts.

 

See Sabah Bank Bhd. v. Ho Juan Hua & Anor [1993] 3 MLJ113

       HSBC v. Sykt United Leong Enterprise S.B. & Anor. [1993] 2MLJ 449

 

9.         REQUIREMENTS FOR A VALID GUARANTEE

 

-         preferably in writing

-         names of guarantors

-         identity card numbers

-         stamped

-         ensure it contains a principal debtor clause

-         signatures of the guarantors

-         addresses of guarantors

-         witnesses to the signatures of guarantors

-         guarantors must be third parties

-         deeming provisions- postage, addresses, etc.

-         conclusive evidence clause

-         manner of service of demand and cause papers

 

10.       SUING ON A GUARANTEE

-Ensure the guarantee is stamped ( Chew Ven Kiet v. Chong Fook Tien [1971] 2 MLJ 157);

- If it is an “on demand guarantee”  a letter of demand must have been sent to the guarantors first before they are sued;

- signatures are authentic/ not forgeries;

            - confirm with the witnesses to the signatures of the guarantors;

            - determine whether the document is a guarantee or indemnity;

- confirm the capacity of the guarantor to sign the guarantee (i.e. not the debtor

   himself;

- whether there is a limit on the guarantor’s liability;

- that all the particulars of the guarantor such as name, i.c. no., address, signature)s) witnesses’ signatures are present

 

 

11. COMMON DEFENCES RAISED BY GUARANTOR-DEFENDANTS

 

*    Non- service of demand:           Ng Hee Thong v. Public Bank Bhd [1995] 1 MLJ *      Signature is different: Ng Yik Seng v.Perwira Habib Bank [1980] 2 MLJ 83

*    Improper demand on guarantors: Mok Hin Wah v. UMBC [1987] 2 MLJ 610

*    Guarantee lacking in particulars: SCB v. Eng Song Huat [1996] 1 MLJ 446

*    Non-Est Factum Tan Lai Wah v. First National Bank of Chicago[ 1984] 1 MLJ 150 PC

*    Undue Influence:HSBC v.Sykt United Leong Enterprise S.B. [1993] 2 MLJ 449

Malaysian French Bank Bhd. v. Abdullah bin Mohd Yusuf & Ors [1991 ] 2 MLJ 475

*   Illegality of Object: Tan Lai v, Mohamed bin Mahmud & Ors[1982] 1MLJ 338

*   Variance of the principal contract.Kidurong Land S.B. v. Lim Gaik Hua & Ors [ 1990] 1 MLJ 485

Development Bank of Singapore Ltd. v. yeap Teik Leong & Ors [1988] 2 MLJ 443

* Sue the principal debtor first: Bank Bumiputra Bhd. v. Esah binti Abdul Ghani [1986] 1 MLJ 16

 

12.       WHEN DOES THE CAUSE OF ACTION ACCRUE?

 

The cause of action accrues when demand for payment is made; See Wee Pee Kuan v. Oversea-Chinese Banking Corp.Ltd. [1982] 1 MLJ 64 FC

 

 

13.       CAUTION:

While a guarantee can provide some form of comfort to businessmen who provide credit to their customers and dealers, the above will show that if the necessary requirements are not complied with, the guarantee document will be useless.

 

A.                 HIRE PURCHASE & LEASING AGREEMENTS

 

1.         ARTIFICIALITY OF HIRE PURCHASE

            The artificiality of hire purchase transactions was well stated by 2 judges  in England.but before we dealwith the comments of these 2 judges we will have to look into the nature of hire purchase transactions.Thus if a customer wishes tobuy a from a car delaer on hire purchase,the dealer will not make the hire purchase contract directly with the customer. The dealer will sell the car to the finance company. The finance company will then let the car on hire purchase to the customer. Thus 3 contracts are involved:

a)      a collateral contract between the dealer and the finance company;

b)      a contract of sale between the dealer and the finance company;

c)      a contract of hire purchase between the finance company and the customer.

 

In Yeoman Credit Ltd v. Apps  [1962] 2 QB 508 Harman LJ said:

“The difficulty and the artificiality about hire-purchase cases arise from the fact that the member of the public involved imagines himself to be buying the article by installments from the dealer ,whereas he is in law the hirer of the article from a finance company with whom he has been brought willy-nilly into contact, of whom he knows nothing and which on its part has never seen the goods which are the subject matter of the hire.”

In Bridge v. Campbell Discount Co.Ltd. [1962] All ER 385 Lord Denning said this about hire purchase transactions:

“If you were able to strip off the legal trappings in which [the present transaction] has been dressed and see it in its native simplicity, you would discover that the appellant agreed to buy a car from a dealer for 405 pounds, but could only find 105 pounds towards it. So he borrowed the other 300 pounds from a finance house and got them to pay it to the dealer, and he gave the finance house a charge on the car as security for repayment. But if  you tried to express the transaction in those simple terms, you would soon fall into troubles of all sorts under the Bill of sale Acts, the Sale of Goods Act and the Moneylenders Acts. In order to avoid these legal obstacles, the finance house has to discard the role of a lender of money on security and it has to become an owner of goods who let them out on hire…So it buys the goods from the dealer and lets them out on hire to the appellant. The appellant has to discard the role of a man who has agreed to buy goods and he has to become a man who takes them on hire with only an option of purchase. And when these new roles have been assumed, the finance house is not a moneylender but a hire-purchase  company free of the trammels of the Moneylenders Acts.

 

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