Classic guarantees

The guarantee is a contract through which guarantors commit themselves towards the creditor of a third party (the so called main debtor) to vouch for the fulfilment of liabilities of the third party. Creditors want to insure themselves with the guarantee in case their debtor is unable to pay. Most of the time, the third party is someone taking a loan and the creditor is a bank granting the loan. The guarantee thus insures the debt of the third party (main debt) as the guarantor's own obligation to pay towards the creditor.

How guarantees work according to German law
The existence of a debt relationship between the creditor and the main debtor forms the basis for the guarantee. This is described as a main liability in German law. A further liability now arises out of the guarantee relationship, and that is the relationship of the guarantor towards the creditor, the guarantee debt. This double claim to satisfy forms the essence of the guarantee relationship. As opposed to mutual contracts, where both parties are entitled and obliged (such as in a sales contract), the guarantee is a contract which obliges only one party. The creditor is only entitled, the guarantor only obliged. There are no obligations to the creditor arising out of the contract.

The respective state of main liability is crucial to the guarantor’s obligation. This principle is described as collateral ability (see § 774 paragraph 1 P. 1 BGB). Basically, the creditor must first file a lawsuit against the main debtor (by trying to enforce it), before he contacts the guarantor. This is ensured by the benefit of discussion (this is the reference to the previous lawsuit against the main debtor) in the trial. However if the guarantor is liable as a principal, he is not entitled to this benefit of discussion.

There is usually a contract or an agency agreement for which fees have to be paid in the relationship between the main debtor and the guarantor. If the guarantor pays the creditor the creditor’s claim against the main debtor is transferred to the guarantor. An important accompanying factor in this legal transfer of the claim is the acquisition of all collateral security rights still remaining to the claim (§§ 774 Paragraph1 P. 1, 401 Paragraph 1 BGB). Due to this legal transfer of a claim (cessio legis) and the security rights that may be connected to it or that arise out of the agency agreement, the guarantor can request a replacement of what was paid from the main debtor or the tolerance of the devaluation of the objects being tendered in the security.  Non-collateral security rights are not transferred to the guarantor in accordance with §§ 774 Paragraph 1 P. 1, 401 Paragraph1 BGB, however after the legal case the guarantor has a private claim to transfer these rights.

Formal requirements for the guarantee contract according to German law:
A written declaration from the guarantor is required for the guarantee to be valid. This should have all the important characteristics of a guarantee according to German law – naming of the guaranteed debt, description of the creditor etc. The formal requirements do not apply to the guarantee of a registered trader. A registered trader can also guarantee verbally if the guarantee is commercial business for him The businessman’s guarantee is always liable as a principal(§ 349 HGB).

Types of guarantee according to German law:

BGB guarantee (ordinary guarantee):

Absolute guarantee:The guarantor has rejected the benefit of discussion as per § 773 Paragraph1 No. 1 BGB. This means that the secured party can contact the guarantor without attempting enforcement against the main debtor.

Guarantee upon initial request:The guarantor initially cannot enforce any objections against the main debt, but is obliged to payment upon request. However, if the secured party did not have any material right to contact the guarantor, the guarantor can, in a second process (so called re-claiming process) ask for the paid amount back. After the legal case, the burden of proof remains with the secured party for the existence of the guarantee. The guarantee upon initial request is inappropriate due to the risk distribution to the disadvantage of the guarantor and is there for ineffective in the general terms and conditions of business. An individual agreement is basically possible.

Indemnity bond:The guarantor is only liable if the secured party cannot be satisfied by the main debtor in spite of observing the required caution (§ 771 BGB).

Modified indemnity bond:  In the case of the modified indemnity bond, the contract stipulates precisely when non-payment has occurred (e.g. it has already occurred if the main debtor/party taking the credit can no longer pay). This means that the bank is in a better position in the case of a modified indemnity bond, since it does not have to execute in the assets of the main debtor first.

Guarantee for a maximum amount:Claims can only be laid on the guarantor for up to a certain amount.

Timed guarantee:The guarantor is only liable for a certain period of time (§ 777 BGB).

Subsequent guarantee: The subsequent guarantor is liable towards the secured party to ensure that the preliminary guarantor (also known as the main guarantor) makes the payment. There is a collateral ability for the subsequent guarantee to become a main guarantee.

Back bond:The back guarantor is liable towards the main guarantor for the recourse claims against the debtor.

Guarantee in bank practice:

In practice, banks ask for an absolute guarantee. This is different to an ordinary guarantee because the guarantor declines the right to benefit of discussion. If the debtor is unable to pay, the bank can take immediate recourse to the guarantor. They thus avoid lengthy and expensive proceedings against the debtor. However the guarantors are usually not prepared to take over guarantees of unlimited amounts. In such cases, a guarantee for a maximum amount is agreed on, where the guarantor is liable up to a certain amount including interest, commission and costs. Banks usually take up specific additional agreements in the guarantee contract:

• The guarantee does not expire in the case of temporary coverage of the debt balance.
• The guarantee is valid for an unlimited period of time.
• The bank’s claims against the debtor are not transferred either partly or fully to the guarantor until the credit has been completely covered.
• If several persons take up a guarantee, their guarantee is a joint guarantee which obliges each participant to take the total debt.

Contracts similar to guarantees:

Not guarantees but related to them are the warranty (warranty contract) and the credit order. Contrary to the guarantee contract, the warranty contract is a reason for a separate new liability.

• Letter of comfort
• Assumption of debt.

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