1. The Law of Contract Act
What is a contract of guarantee?
Section 78 The Law of Contract Act defines a contract of guarantee as a contact to perform the promise or discharge the liability of a third person in case of his default.
There are three key players in a contract of a guarantee, which makes the con- tract a tripartite one (Section 78 the law of contract Act)
- A surety/guarantor – a person who gives a guarantee
- A principal debtor – a person in respect of whose default the guarantee is given
- And a creditor – the person to whom the guarantee is given
Guarantees are subject to general contract law principles such as:- offer, acceptance, intention to create legal relation, capacity and consideration:-
What is the taste of consideration in a contract of guarantee? Anything done or any promise made for the benefit of principal debtor may be a sufficient consideration to the surety for giving the guarantee.
- In other wards any promise made for the benefit of the principal debtor is presumed by law to be sufficient consideration. Just like any other contract a con- tract of a guarantee without consideration is void. Section 79 of the Law of Contract Act.
Lenders often rely on guarantees provided by corporations and individuals for third party debts as a form of security. While both corporate and personal guarantees justifiably provide lenders with some comfort, they do not in themselves create a security interest and there are various aspects a cautious lender must be aware of in respect of such guarantees –
- The obligation of a guarantor is incidental to the obligation of the principal debtor. Any discharge of the principal debtor’s obligations may, therefore, result in the guarantee no longer being valid.
- If the principal debtor becomes bankrupt, the creditor must prove its debt in the bankruptcy, failing of which it will lose its right to claim against the guaran- tor to the extent of any sums which the creditor might have received had it proved such debt in the bankruptcy; and
- It is important to note that unless a guarantee is backed by security, a lender’s claim on the guarantor will be unsecured. This could subordinate the lender’s claim to other lenders who have obtained security from the guarantor in the form of a mortgage or a pledge over the assets of the guarantor.
Importance of Due Diligence of Guarantor’s Assets
All lenders must undertake the necessary due diligence prior to the execution of a guarantee in respect of the nature of the guarantor’s assets. In terms of enforcement, it is important to note that our laws do not recognize the concept of ‘self-help remedies’.
As such, guarantees in Tanzania must be enforced through a process led by the courts – The lender will require an attachment order, once a final judgment has been obtained, in order to recover the monies due under the guarantee – In order to increase the expediency of the attachment process, lenders should conduct the necessary due diligence and obtain all details of the unencumbered assets of the guarantors, including but not limited to funds in bank accounts, real estate proper- ties, immoveable properties, vehicles, shares/stocks etc. The advantage of identifying the assets is that it would assist the court in an expedient issuance of the attachment order.
Extent of Guarantor’s Responsibility Under the Law of Contract Act (Co-extensive principle)
The liability of the guarantor is co-extensive with that of the debtor in question as seen under section 82.
The term ‘co-extensive’ has been defined by Pollock and Mulla (Indian Contract and
Specific relief Act Tenth Edition page 728) as:
‘Co-extensive means that a surety’s liability to pay the debt is not removed by reason of the creditor’s omission to sure the principal debtor. The creditor is not bound to exhaust his remedy against the principal debtor before suing the surety, and a suit may be maintained against the surety though the principal has not been sued.’
This has further been addressed in Halsbury’s Laws of England with the observation that:
‘… it is not necessary for the creditor, before proceeding against the surety, to request the principal debtor to pay, or to sue him, although solvent, unless this is expressly stipulated for.’
Thus, it is manifest that the guarantor’s liability stands on a co-extensive footing with that of the surety, and that the principle borrower can, by way of a remedy against an outstanding debt, proceed equally against the debtor or the guarantor, in no particular order of preference.
Such co-extensive liability is, however, subject to the terms of the contract.
The provision of S.8O Of the Law of Contract Act qualifies the nature of the co-ex- tensive liability by making it subject to the terms of the contract.
The words ‘unless it is otherwise provided in the contract’ occurring in that section of the Act suggests that the contracting parties may altogether agree to con- tract out of such a provision specifying co-extensiveness of liability as against the guarantor.
It is important to note that, if there is variance in terms of the contract without the surety’s consent, the surety is automatically discharged; this therefore means the principle would not apply. Section 85 of the law of contract Act
The Companies Act in Respect to Guarantees
S.200 (1) provides that, it is unlawful for the company to do the following:-
- To make loan to:-
- Its directors
- Directors of its holding company
- A connected person
Illustration of 1 (b):
Company “X” is a subsidiary of company “y”. The directors of company “y” are Tom and Jerry. Therefore Company “x” is barred to give loans to Tom and Jerry.
- To provide guarantee or security of a loan for:-
- Its directors
- A connected person
A connected person as defined under section 200(4) of the Act means;
- A director’s spouse, child, step child, or a body corporate in which the director or any such other person has a direct or indirect interest of twenty per cent or more in the share capital,
- A trustee, acting as such of any trust of which beneficiaries include any of the person mentioned under paragraph (1) above, and
- A partner, acting as such, of the director or any one of the persons mentioned in paragraph (1) and (2) above.
Our focus will be on “a body corporate in which a director or any such other person has a direct or indirect interest of twenty per cent or more in the share capital”.
This means that, a director or any other person in a company that intends to guaran- tee another company should not have any direct or indirect interest of 20% or more in the share capital of that other company.
Due to the known structure of companies, other persons in the company may mean; a shareholder, company secretary and manager.
Since Tom is a shareholder in company “x” and also holds 20% interest in Company “Y” automatically Company ”Y” becomes a connected person to company “X” as defined under section 200(4) (a). The same would apply if Queen or King or Jerry or dog owned 20% interest in Company “Y”.
However section 200(1) (a)-(c) provides circumstances which a company may waive the limitations provided for under section 200(1);-
1. Subsidiary Company vs. Its Holding Company as Its Director:
Section 200(1) (a) provides that, if one of the directors in a subsidiary company is its holding company, the company is not barred to give loan/guarantee to that director.
Illustration:
Company “X” is a subsidiary of company “Y”. Company “Y” is a director in company “X”. In this scenario, company “X” is not barred to give loan/guarantee to company “Y”.
2. To Provide Funds to Meet Expenditure or to Enable an Officer of the Company to Perform His Duties:
Section 200(1) (b) provides that, if loan/guarantee is to be given to any of the prohibit- ed persons as indicated above, the purpose of the said loan/guarantee should be;-
a. To meet expenditure incurred or to be incurred for the purpose of the company
b. To enable the director/connected person to properly perform his duty
Illustration for a:
- Money is given to the mentioned persons to buy a car to be used by Company X.
- Company “X” guarantees its director/connected person in favor of Benson & co, for the said director/connected persons to be given computer(s) for company use and pay when they have cash.
Illustration for b:
- Money is given to the mentioned person(s) as officer(s) of the company to buy a car to be used by that person(s) for easy of movement in performing the activities of the company.
- Company “x” provides guarantee its director/connected persons in favor of Image Motors for them to be given a car for easy of movement in performing the activities of the company and pay when they have cash.
However, for the company to enjoy what is provided for under section 200(1) (b), the following conditions should be met:
a. Prior approval of the company at the general meeting or
b. If no approval is given in the general meeting the company can only issue a loan or guarantee on a condition that the said loan will be repaid or the liability under the guarantee will be discharged within six month from the conclusion of that meeting.
3. Company’s Ordinary Business is to Give Loan/Guarantee:
Section 200(1) (c) provides that, if the company’s ordinary business is to give loan/guarantee; the company is not barred to offer such services to its directors or connected person.
Illustration:
The ordinary business (as per the Memorandum of Association and other regulatory compliance) of Company “x” is to give loan/guarantee. The directors of company “x” are Tom and Jerry. Company “x” can lend and guarantee Tom and Jerry.
Chattel Mortgages in Tanzania
What is a chattel? Section 2 of the Chattels Transfer Act cap 210 defines a chattel as any movable property that can be completely transferred by delivery. It includes machinery stock and the natural increase of stock- crops and wool.
A chattel mortgage is a loan that is secured by a chattel rather than by real property.
Law governing chattel mortgages
- Chattel transfer act Cap 210.
- Merchant Shipping Act 2003
- Civil Aviation (Aircraft Registration and Marking) Regulations
Characteristics of a chattel mortgage
- It’s a formal contract
- Delivery of personal property to the mortgagee is not necessary
- Registration is a requirement of the law
- Registration is within 21 days from date of creation the instrument
- Procedure for attaching chattels is different
- If the property is foreclosed and there is excess the amount goes to the debtor
What can be considered as a chattel mortgage?
Cars, aircrafts, ships, mineral rights, books or other debts, negotiable instruments and choses in action. A mortgage created by an individual over chattels, book or other debts, negotiable instruments among others.
A mortgage over mineral rights must be registered in Registers of Minerals Rights established under section 105 of the Mining Act, Cap. 123.
A mortgage over registered ships must be registered in the register of ships under section 88 of the Merchant Shipping Act, 2003.
A mortgage over an aircraft can be registered by way of title sharing under Regulation 6 of Civil Aviation (Aircraft Registration and Marking) Regulations, 2006.
If the mortgage over any of the stated assets exceeds five years, it must be renewed after five years (See section 10 of the Chattels Transfer Act).
Registration of a chattel mortgage and effect of non-registration
Registration of an instrument under the Act is mandatory. It’s effected by filing the instrument and all the schedules endorsed on.
Section 13 of the Chattels Transfer Act states that every instrument shall after expiration of 21 days from execution of the instrument be deemed void if unregistered.
The foregoing does not constitute legal advice, rather only an overview. Readers are cautioned against making any decisions based on this article alone. Specific legal advice should be sought.