Legal Articles / Banking Law


An Introduction to Corporate Guarantee

banking law

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November 02, 2014


In the UAE, the risk management activities inherent in running a corporate or investment banking business remain of crucial importance, not least because of the strong local characteristic of “name lending”, by which is meant lending or providing other banking facilities to family or other private businesses, primarily on the strength of the “name” or “names” of the proprietors standing behind the business, rather than on the strength of the asset quality and underlying credit of the particular business. Of course, in practice, there is commercial overlap between the proprietors and the companies which they own, but the credit analyses can break down where poor banking practices and procedures result in poorly constructed legal documentation and gaps in guarantee and security support documents.

Many business organizations and institution have an option of entering into corporate guarantee agreement for obtaining funds, or the capital. The implications of corporate guarantee are far-reaching, and its execution requires a tedious examination of facts of each case.

We have attempted to analyze the law on this subject and have provided an overview on laws governing corporate guarantee.

Contractual Undertaking

The Guarantee agreement should be unequivocal in its terms and should clearly define the rights and obligations of the Principal debtor and Guarantor, as per the laws of UAE. Law No. 5 of Civil Procedure Code, Article 1078 (the Law).

According to its provision, a bank can claim against both parties (one who guarantees and one who is a beneficiary in the guarantee agreement) provided one of the parties defaults on any payment. This provision encourages banks to lend based on corporate guarantee and ensures that the debt is recoverable from either of the parties involved in the transaction – principal debtor and corporate guarantor.

UAE legislation contemplated guarantee by way of suretyship only. There is a time period for enforcement. The common practice by banks in UAE is to take undated Guarantee Cheques from Guarantor and ensure that their risk is fully covered. The lack of sufficient funds in bank account could ensure criminal proceedings against the drawer of cheques and criminal proceedings are relatively straightforward to pursue.

Guarantee Agreement should be correctly executed and dated. The Agreement should clearly define the execution period, length of Agreement and conditions that will kick in expiry of Guarantee Agreement. This should be taken into consideration during the time of execution of Agreement.

Commercial Guarantee and Court precedents

The UAE courts’ precedents are also not uniform in defining a “commercial guarantee” as distinguished from a “civil guarantee” for the purpose of Article 1092. In cassation petition 201/1992 and another 1997 precedent (Dubai Cassation petition 85/1990), Dubai courts held that a guarantee may only be regarded as commercial if it’s offered for a consideration or in connection with the guarantor’s trade. However, in a more recent precedent the court adopted a more flexible criterion regarding a guarantee as commercial if the guaranteed debt is a commercial one i.e. a debt which arose in the course of the original debtor’s trade, or where the guarantor is a trader or derives some benefit from providing the guarantee. Most reported cases in fact hold the position that the legal description of a guarantee i.e. whether it is civil or commercial, follows that of the guaranteed debt.

In the light of above and other reported cases, the current position in brief seems to be as follows:

1 – A guarantee is regarded as commercial if the underlying debt is commercial.

The provision of Article 1092 may be contracted out in situations in which they would otherwise be applicable, on the grounds that the rule is therein is not a matter pertaining to public order and is not accordingly mandatory.

Debt Originating from Guarantee and Termination

A debt becomes mature upon its Due Date.

The issue under consideration here is the confusion created by conflicting judgements relating to the effects and implications of Article 1092 of the Code of Civil Transactions (Civil Code).

Expiration of Guarantee is elaborated in Article 1099 of the Law:

A guarantee shall expire in the following cases:

  1. Upon payment of the debt.
  2. Upon deterioration of the real property in the hands of the guaranteed by a force majeure before a claim is made.
  3. Upon termination of the contract under which the right becomes binding upon the guaranteed.
  4. Upon discharging a liability creditor of the guaranty or a debtor of the debt.
  5. Upon death of the guaranteed.

Termination may also kick in due to Article 1101, it states:

“If the guarantor or the debtor compounded the creditor of amount of the debt, they shall be acquitted from the rest. If the quittance was provided only for the guarantor, the creditor may choose between taking compounded amount of the rest from the principal or leaving the guarantor and claiming the principal by all debt”.

This means that if there is an agreement between guarantor, debtor and creditor on the part of debt and if that debt is settled, then remaining debt will be waived automatically. The agreement should specify in clear terms if parties which to waive guarantor’s liability. If it is stated that Guarantor will not be liable, then this agreement will close the deal and termination will kick in. This means that Guarantor’s liability can be excluded with the help of this Agreement, Therefore the creditor may choose to claim the debt (either partially or in full) from the original debtor.

Conclusion

To put it simply, UAE laws provide for enforcement of corporate guarantees ion the courts. The laws are strictly defined and courts practice suggests that there might be a few discrepancies in its enforcement, however, but the broader idea remains clear and focused. If the Guarantee Agreement clearly defines the rights and obligations of Guarantor, principal debtor and beneficiary then such Agreement remains valid and enforceable at law. It might be suitable for the lending institution to take security cheques from the guarantor or debtor, and if any of those cheques bounces due to the lack of sufficient fund, then lending institution will have recourse to criminal proceedings against signatory authority in the Guarantor’s company to claim the outstanding amount. Lending institution should also consider about debt maturity and should claim any amount within six months, as per the Article 1092 of the Law.

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