Finance

How Does Guarantee System Work in India

How Does Guarantee System Work in India

Introduction:

The Guarantee is a legal term more comprehensive and of higher import than either warranty or “security”. ” It more generally refers to a private exchange where one party undertakes to be accountable to him in order to gain some trust or credit from another party. It may also designate a convention where rights, privileges, or possessions are given.

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It is to be distinguished from the “personal guarantee” colloquial in that a guarantee is a legal term that produces an economic effect. In contrast, a personal guarantee is often used to refer to a promise made by an individual who is supported by the individual’s word, or assured through it. Likewise, a guarantee creates a legal result whereby one party claims the obligation (usually payable) of another by agreeing to pay itself if a default happens.

A financial guarantee may be considered a form of bank guarantee. In essence, in the event of the borrower’s default, a specialized insurance company is obliged to repay the remaining interest payments and the principal amount of a bond or similar financial instrument to the lender. Note that in transactions involving different financial instruments and structured products the financial guarantee can be used.

How Does a Guaranteed Loan Work:

  • Suppose Company XYZ wants to borrow $100,000 from a bank to purchase a piece of equipment. Since the company would be responsible for the loans, owner John Doe is likely to be asked to provide a personal guarantee on the loan. In doing so, John Doe offers to repay the loan using cash flows from other areas of his life and properties if Company XYZ cannot produce sufficient cash alone to repay the debt.
  • Guarantors don’t always guarantee the full liability amount. For example, they could only guarantee interest or principal repayment but not both. Sometimes more than one person may guarantee a loan; in these situations, each guarantor is typically only responsible for a portion of the debt pro-rata, but in some instances, each guarantor could be responsible for the portions of the other guarantors if they also default on their obligations.
  • The loan guarantee usually will be provided by the lender. Its exact terms will vary depending on the lender, and the laws of the jurisdiction. Many, if not all, of the provisions of the arrangement, will be intended to safeguard the investor.
  • The agreement may create an absolute or unconditional guarantee, which obligates the guarantor for the debt if the borrower defaults for any reason. Or the arrangement can only obligate the guarantor if certain conditions have been set out. For example, it may require the lender to seek all legal options for recovery against the creditor first, before turning to the payment guarantor.
  • The guarantee shall also be subject to further limitations. For example, if the loan is guaranteed and the borrower does not have the 10 percent down payment usually required, then the guarantor will only be found responsible for that 10 percent. The arrangement will also allow for the waiver of the liability of the guarantor until a sufficient sum of equity has been made available. Besides the kinds of clauses included in virtually every contract, there are clauses special to loan guarantee arrangements, such as:
    1. Guaranty of payment and not of collection:- A declaration to this effect allows the creditor to automatically go after the guarantor on default, without first requesting collection from the creditor.
    2. Liability for attorney fees and other costs of collection against the borrower: – That goes beyond making the guarantor liable for costs of pursuing the guarantor’s collection.
    3. Waiving right to notice of default: – Although one would think that a lender’s responsibility should be to notify the guarantor promptly in case the borrower defaults, this is specifically avoided by the loan guarantee agreements of most lenders.

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The requirements of the lender, and possibly state law, will determine whether the personal guarantee loan agreement must be witnessed or notarized. If the loan covers real estate, the agreement would most certainly have to be observed and notarized in the same way as a deed.

To a guarantor, it is important to read and understand the loan guarantee agreement. You may want to work with an attorney to assist in the drafting of a loan guarantee agreement to ensure that you are properly covered in your capacity as the loan guarantor.

 

Author: Pruthviraj Sondani

About the Author: One day I will find the right words, and they will be simple.

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