TO GUARANTEE OR NOT? RIGHTS OF LOAN GUARANTORS IN KENYA

So you FINALLY joined the Shiny new Sacco that was referred to you by your friend. After a few months and some hefty amount of savings down the road, the same friend approaches you to be their guarantor, they want to take a loan. You have just sat down at your desk from a heavy bout of lunch at your favorite four-star kiosk "kibandaski". Your friend brings the Loan application forms and informs you in passing as they chow down a huge BANANA, that they want to finish a small project "kaproject" back home and they need an urgent loan of KES 500,000 from the Sacco. In fact, they are at the roofing stage. They request that you guarantee them at least KES 200,000. You quickly sign the Loan Application form and indicate the amount without even reading through the document. I mean what could go wrong?

A few months later you realize that your Salary and Sacco shares have been deducted. Guess what, your friend took the loan to fund a holiday to the Mara TO GO BAM BAM AND CHILL WITH THE BIG BOYS, meanwhile Your Salary and Sacco shares have run KITI KITI AND KATA KATA and all you can sing is AMENO, AMENO (Kindly google the song ameno amapiano remix to understand the pun). They even revamp their furniture. New Leather Seats and a Big Screen which would make your 32-inch tv blush in admiration. Your friend has defaulted in the payment of the loan. They did not even have the courtesy to inform you that they were having challenges in servicing the loan. Every month is gnashing of teeth and wailing as you seek the elusive justice and you receive 1/2 of your salary. Your friend is just enjoying their life what in slang parlance is referred to as "ENJOYMENT".

Hence we Tackle the Big Question, To GUARANTEE OR NOT TO GUARANTEE THAT NECESSARILY EVIL, THE LOAN?

1.  APPURTENANT LAWS

The Law on Guarantorship in Kenya is founded on the following Precepts:

1.1             the Constitution of Kenya, 2010

1.2             the Law of Contract Act Cap 23, Laws of Kenya (the LCA )

1.3             case law (decided cases)

2.         WHAT IS THE POSITION OF THE LAW IN RESPECT TO GUARANTEES?

An agreement of guarantee is covered and regulated by the Law of Contract Act, Cap 23, Laws of Kenya (the LCA) which stipulates that a contract of Guarantee is a written promise by the Guarantor to answer for the debt of the Principal Debtor made to a lender.

Specifically, the LCA provides at Section 3 (1) that the Guarantee shall be in writing and signed by the Guarantor.

“No suit shall be brought whereby to charge the defendant upon any special promise to answer for the debt, default or miscarriages of another person unless the agreement upon which such suit is brought, or some memorandum or note thereof, is in writing and signed by the party to be charged therewith or some other person thereunto by him lawfully authorize.”

Interestingly, On or around February 2019, a bill was introduced in Parliament to amend the Law of Contract Act Cap 23, Laws of Kenya by introducing Subsection 3(1A): “Notwithstanding Subsection 3(1), before a suit is brought against a defendant under subsection 3(1), the Plaintiff shall first realize the security of the principal.”

 The reasoning behind the failed amendment was that since it is only the Principal Debtor who benefits solely from the loan, the Creditor should exhaust the Principal Debtor’s security before pursuing the Guarantor. The amendment would also prevent the current unfair situation where the Guarantor’s assets are taken over while the Principal Debtor still has assets that can be utilized to satisfy the debt.

SADLY, the proposed amendment was rejected by the President of Kenya for the reasons that the amendment would negate a long-standing principle of contract law, interfere with the operations of the capital markets, prejudice the financial sector, and adversely affect credit advanced to micro, small and medium enterprises.

3. WHAT ARE THE RIGHTS OF GUARANTORS BEFORE SATISFYING THE DEBT OWED BY THE PRINCIPAL DEBTOR?

a. Firstly, the Guarantor has a right to ownership of property and not be arbitrarily deprived of any property of any description or any interest in, or right subject to Article 40 of the Constitution.

b. The category into which any guarantee fits is determinable depending on the terms contained within it. For example, a guarantee can stipulate that it is payable “on first demand”. Such a guarantee would become payable immediately after the first demand has been made. A guarantee of that kind is called an “On-Demand Guarantee”. On the other hand,  a guarantee which becomes payable only when specified conditions have been met is called a “Conditional Guarantee”. In such cases, the most important factor to consider before liability can attach is whether the Principal Debtor has defaulted.

c. As a matter of the law, the Guarantor’s liability will not arise before the default by the Principal Debtor to pay the debt. And even if demand by the Creditor to the Principal Debtor may not be a strict requirement in guarantee, however, civil procedural law which governs civil suits may make a demand for payment of debt statutorily imperative or desirable. This effectively means that the Creditor should first make a demand for payment in writing from the Principal Debtor.

d. The Guarantor has a right to call on the Principal Debtor to pay the amount of the debt guaranteed. See Halsbury’s Laws of England, Fourth Edition Reissue) Vol 20(1) para 239 that:-

“When a creditor has acquired a right to immediate payment of the debt from the guarantor, the guarantor is entitled to call upon the principal debtor to pay the amount of the debt guaranteed, so as to relieve the guarantor from his obligation, even though the guarantor, has paid nothing under the guarantee, even though the creditor has not demanded payment from him or the principal debtor’’.

In principle, That Creditor ought to issue the Guarantor with sufficient notice of default by the Principal Debtor and demand for payment.

e. Lastly, the Guarantor is entitled to accurate, verifiable, timely, and regular accounts and updates from the Creditor in relation to the Loan, pursuant to Article 35 of the Constitution that provides for the rights of access to information held by another person that is required for the protection of any right or fundamental property.

4. WHAT ARE THE EFFECTS OF VARIATION OF TERMS OF GUARANTEE e.g SUCH AS THE SALARY (COLLATERAL) PAY POINT?

a.  In the case of; Reid-Vs- National Bank of Commerce (1971) E.A.525, it was stated that “the law has always been jealous to protect a guarantor who, especially in a continuing and fluctuating liability, is very much at the mercy of the creditor”.

b. In Halsbury's Laws of England, 3rd edition vol.18 pages 253-257 and Bullen and Leake, on Guarantees 10th edition, page 603, it is stated that “if after giving a guarantee, the creditor, without the authority or consent of the surety, alters the contract made with the principal debtor, the surety is thereby discharged on the ground that he cannot be made liable for non-performance of a contract he has not guaranteed”.

c.Further, in HALSBURY’S Laws of England, Fourth Edition, Volume 20 (1) para 324 page 210 it is explained that;

“The basis of the principle that a guarantor is discharged by an agreement between the creditor and the principal debtor which has the effect of varying the guarantee, is that it is the clearest and most evident equity not to carry on any transaction without the privity (knowledge) of the guarantor, who must necessarily have a concern in every transaction with the principal debtor, and who cannot as a guarantor be made liable for default in the performance of a contract which is not the one the fulfillment of which he has guaranteed.

d.  Further in the case of; Holme-vs- Brunskil (1878) 3QBD; it was stated that

“ if there is any agreement between the principals with reference to the contract guaranteed, the surety ought to be consulted, and if he has not consented to the alteration, although in cases where it is without inquiry evident that the alteration is unsubstantial, or that it cannot otherwise be beneficial to the surety, the surety may not be discharged; yet that, if it is not self-evident that the alteration is unsubstantial, or one which cannot be prejudicial to the surety, the court will hold that in such case the surety himself must be the sole judge whether or not he will consent to remain liable notwithstanding the alteration, and that if he has not so consented he will be discharged. Accordingly, whenever a creditor seeks a variation in terms of his contract with the principal without the knowledge or consent of the surety, he does so at his own risk, and unless the benefit or lack of prejudice to the surety is obvious, or there is obviously no possibility of prejudice, the surety will be entitled to be discharged.”

What this means in effect is that the guarantor may be discharged from a guarantee where there has been a variation of the original facility to which he has not been privy, and has not consented.

5. WHAT ARE THE EFFECTS OF A CREDITOR/SACCO NOT ACTING IN GOOD FAITH?

a.  In Halsbury’s Laws of England, 5th edition, Volume 49 at page 561 it is stated that a guarantor will be discharged from his obligations if the creditor acts in bad faith towards him, or connives at the default of the principal debtor in respect of the guarantee.

b.  In Martin Kirima Baithambu v Jeremiah Miriti [2017] eKLR: Judge F. Gikonyo held and stated, “The Applicant who is a Guarantor has not yet paid the guaranteed debt. However, he has alleged that the Principal debtor is able to pay the principal debt except that the creditor has colluded with the principal debtor not to call for payment from the principal debtor but the guarantee in order to fleece the guarantor. That is a substantial matter in the law of guarantee about which I find myself having to examine the rights of a Guarantor before he satisfies the guaranteed debt. Thus, but without overriding the guarantee, modern guarantee and equity anticipate that the creditor should signify good faith towards the guarantor.

The said intervention by equity supplements but does not replace the contractual rights and processes under the guarantee; see it within equitable protection of the guarantor especially where the creditor acts in bad faith towards the guarantor or connives at the default by the principal debtor on a matter in respect of which the guarantee was given. In this case, bad faith, connivance, and collusion to fleece the guarantor have been alleged against the creditor and the principal debtor. Applying the above principle, the material available- which was not controverted- shows that the principal debtor still plies and carries out transport business with the vehicle in respect of which the guarantee was given. The Guarantor has alleged that the creditor is fully aware of these facts including that the principal debtor is able to pay up the debt. Except, however, the two have colluded to fleece the guarantor by calling up for the guarantee without demanding payment of the debt by the principal debtor. He stated that he should be allowed to stake his defense in the suit between the creditor and the Guarantor. The assertion leads me to state the following.

There that there is no absolute restriction in law on joinder of the principal debtor in a suit based on guarantee especially where bad faith, connivance at default by and collusion with the principal debtor has been alleged against the creditor. This is a substantial matter of law that could justify granting of a stay of execution pending appeal. But before I close, as the guarantor intends to introduce the principal debtor in the suit by the creditor to enforce the guarantee.”

6. WHAT ARE THE DEFENCES/REMEDIES/CLAIMS AVAILABLE TO THE GUARANTOR?

A Guarantor has the following remedies, defenses against claims for non-fulfillment of guarantee obligations by the Principal Debtor:

a. That there has been a variation to the contract of Guarantee such as a change of the FOSA PAYPOINT or increment of loan amount by the Principal Debtor: In the case of Bolton v Salmon [1891] 2 CH 48 the court stated that where the agreement between the principals is amended in a way that is not obviously unsubstantial or for the benefit of the guarantor without his or her consent, then the guarantor is discharged. Similarly, if the loan amount is increased without the guarantor’s consent, the guarantor would be released from the obligation.

b. That the Creditor has released the Debtor’s security such as the Salary through the change of the FOSA PAYPOINT by the Principal Debtor: In the case of Re Walker, Sheffield Banking Co v Clayton [1892] 1 CH 621) the court affirmed that where a creditor releases security, the guarantor would have a defense for non-fulfillment of guarantee obligations.

7. RECOMMENDATION AND CONCLUSION

Generally, the law on Guarantorship in Kenya favors the Creditor rather than the Guarantor. The proposed amendment of the LCA was meant to cure the current situation where many creditors are quick to attach the salaries or assets of the guarantors since it is cheaper and easier than realizing the Principal Debtor’s assets.

 Conceptually, the Guarantor who has settled the Debt will file a case against the Principal Debtor under the principle of subrogation and will invoke the name of the Creditor for indemnification by the Principal Debtor.

As such the Guarantor will have a claim against the Creditor/Sacco and the Principal Debtor on the grounds and proof that there was a variation of the contract, and the Creditor released the Debtor’s security.

Further, the Guarantor can therefore go-ahead to sue the Creditor/ Sacco and the Principal Debtor on the grounds and proof of bad faith, connivance, and collusion. 

As is self-evident, the legal remedies for a Guarantor are as slim as a Victoria Secrets Model (pun is mine and intended). If you guarantee that loan, be ready to forfeit your salary and assets. My advice would be to seek legal advice first before putting pen on paper and conducting proper due diligence on your alleged friends. Else you and your Salary shall be Erstwhile.

If you have any questions or require assistance on this topic kindly feel free to contact me on my email at william.karoki@prow.co.ke.

Drafted on 03/01/2021 3.09 pm by William Karoki-Managing Partner at WKA Advocates, william.karoki@wka.co.ke.The author strives to convey information in plain English