Typically, in any financing transaction, to protect against financial vulnerability, banks and other lending institutions alike will take some form of security which is essentially an asset pledged by the borrower as protection to the lender in case he defaults on his repayment

Suretyships and guarantees although both are forms of security for a principal obligation there is a significant difference between these two forms of security. As a general principle guarantees create independent principal obligations while suretyships create accessory obligations.

A suretyship is a contract between a creditor, a principal debtor and a third party binding himself in part or in whole on behalf of the principal debtor, usually as surety and co-principal debtor. In his personal capacity the surety undertakes to step into the shoes of the principal debtor and pay the creditor if the principal debtor cannot. There can be no surety if there is no principal obligation. There are legal exceptions (such as an obligation on the creditor to look to the principal debtor first, before proceeding against the surety) that are invariably waived in the suretyship agreement. This means that the creditor need not seek to recover the debt from the principal debtor first before enforcing the agreement against the surety.

A surety is accessory in nature, which means it cannot exist without a principal obligation, for example, Bank X (creditor) loans Company Y (principal debtor) a sum of money and the Director of Company Y, as a form of security, signs as surety to the loan agreement concluded between Bank X and Company Y. The principal obligation is for Company Y to pay Bank X the finance debt on the sum loaned). The Creditor Bank X can therefore only claim performance of the obligation from the surety (Director of Bank Y) to the extent that the principal debtor (Company Y) fails to perform unless waived in the suretyship agreement. The obligation to pay or fulfil the obligation under a surety is also only created when the surety is validly called upon by the creditor. 

In terms of common law, a surety is discharged if the principal obligation is extinguished, for example, due to performance by the principal debtor or to impossibility of performance or invalidity of the debt.  A suretyship may also be terminated if the accessory obligation between him and the creditor is extinguished even though the principal obligation between the principal debtor and the creditor is still in force. A surety agreement must also be in writing in order to be valid.

CAN A DEED OF SURETYSHIP SURVIVE IN CIRCUMSTANCES WHERE A PRINCIPAL LOAN WAS INVALID?

In a unanimous judgment penned by Froneman J (with Mogoeng CJ, Cameron J, Jafta J, Khampepe J, Madlanga J, Mathopo AJ, Mhlantla J, Theron J and Victor AJ concurring), the Constitutional Court in Shabangu v Land and Agricultural Development Bank of South Africa 2020 (1) SA 305 (CC) overturned the judgment by the Gauteng Division, of the High Court (Pretoria) which had ordered the applicant (Mr Shabangu) and the third to eighth respondents to pay, jointly and severally, an amount of R82 million to the first respondent, the Land and Agricultural Development Bank of South Africa (Land Bank).

the Land Bank lent and advanced funds to Westside Trading 570 Pty Ltd (Westside Trading) in terms of a written loan agreement for the purposes of developing urban property. Included in the security package for the loan were signed suretyships by Mr. Shabangu and eight others (sureties). Following the conclusion of this transaction, it became known by the Land Bank that the loan agreement was invalid as it did not meet the developmental objectives contemplated in s 3 of the Land and Agricultural Development Bank Act 15 of 2002. Westside Trading was placed under provisional liquidation and wound up in 2012 hence the Land Bank bought its claim against the sureties for the outstanding debt.

Relying on the Supreme Court of Appeal judgment of Panamo Properties 103 (Pty) Ltd v Land and Agricultural Development Bank of South Africa 2016 (1) SA 202 (SCA), the High Court held that it did not necessarily follow that the invalidity of the principal loan agreement meant that the deed of suretyship, as an ancillary agreement, was also invalid.  The High Court held that, on a proper interpretation, the concept of indebtedness in the deed of suretyship contemplated the acknowledgment of debt.

Mr Shabangu argued that an acknowledgment of debt cannot validate the alleged indebtedness under the invalid loan agreement, irrespective of whether the acknowledgment of debt is characterised as a novation (the replacement of one valid contract with another valid contract) or a compromise (an agreement for the purpose of preventing, avoiding or terminating a dispute).  He sought to distinguish Panamo on the basis that it concerned a mortgage bond rather than a deed of suretyship in the context of an unjustified enrichment claim. This is the crucial difference between the claim under the Panamo case and the present case. The court stated that, as was seen in panamo, a valid debt is not necessary for an enrichment claim to arise. In Panamo, the court emphasized that a mortgage bond can secure more than the obligations contained in a loan agreement, and given that it could contain primary obligations (as opposed to accessory obligations) such primary obligations could, therefore, not be extinguished by the invalidity.

The CC distinguished the matter from Panamo on the basis that it concerns the question of whether a deed of suretyship (rather than a mortgage bond) can establish accessory liability in respect of the compromise of an unlawful principal obligation (rather than a valid enrichment claim).  While the acknowledgment of debt could have entailed a valid compromise, such as the compromise of an enrichment claim, the Court found that it was invalid in this case because the acknowledgment of debt sought to perpetuate the original invalidity of the loan agreement.  The Court accordingly held that there is no valid claim against Westside in terms of the acknowledgment of debt, and thus also no valid claim against the sureties.  In the result, the appeal was upheld with costs.

A guarantee contract on the other hand is based on ‘primary’ liability and exists independently of any underlying obligation by the principal debtor to the creditor.

It is an undertaking by a guarantor (Director of Company Y) to pay or fulfil an obligation to a creditor (bank X) upon the occurrence of a certain event. In the case of an independent guarantee the obligation of the guarantor to pay is principal in nature and exists independent of an underlying obligation or the existence of any other debt. 

Such a guarantee can be demanded once the agreed conditions of such guarantee have been met. Once it has been determined that the conditions of the guarantee have been met, the guarantor is obliged to perform in full as contracted. The liability of the guarantor under a guarantee is equal to the amount, which is guaranteed, whether or not the guarantee is called upon. A guarantee can only be discharged if there is performance of the principal obligation or payment on the part of the guarantor. A guarantee does not have any formal requirements such as having to be embodied in a written document, although it is strongly recommended to record the terms of a guarantee in a valid written agreement.

A guarantee is therefore generally seen as a stronger form of security than a surety which is accessory in nature as it establishes independent liability for the principal obligation.