Guarantees are standard practice in loans, leases, and corporate group financing across Canada. However, the legal and commercial risks they create are frequently underestimated by directors, creditors, and the guarantors themselves.
This article breaks down what a guarantee involves, the common risks that may affect its enforceability under Canadian and specifically Ontario law, and the enforcement rights available to creditors.
What is a guarantee?
A guarantee is a promise by one person (the guarantor or surety) to answer for the debt or obligation of another person (the principal debtor or borrower) if the principal debtor fails to pay or perform. For individuals, this promise is known as a Personal Guarantee (PG), which Ontario courts strictly enforce, often leading to the seizure of the guarantor’s personal assets, including savings and homes, if the borrowing business defaults.
What is a guarantor’s obligation?
A guarantor’s obligation is fundamentally secondary; they are only liable if the principal debtor remains liable for the debt and fails to perform its obligations.
However, in commercial lending and in Ontario practice, parties routinely draft the guarantor’s obligation as an irrevocable and unconditional principal obligation, requiring payment on demand “as if it were the principal debtor”. This contractual language makes the liability independent and primary, often overriding common law defences.
In practice, common clauses found in Ontario guarantees ensure the guarantor’s liability is not affected by:
- Any extension of time or other indulgences granted to the principal debtor.
- Any change to the terms, covenants, conditions, or provisions of the Guaranteed Obligations.
- The lack of validity or enforceability of any underlying document or security.
What are a guarantor’s rights?
As a party assuming obligations, a guarantor is afforded several common law rights, though these are routinely modified or limited by the terms of the guarantee document:
- Indemnity (Reimbursement): The guarantor generally has a right to recover any amount paid under the guarantee from the principal debtor, as the debtor remains primarily responsible.
- Subrogation: After the debt is satisfied, the guarantor may step into the creditor’s position and rely on the creditor’s rights and securities against the principal debtor.
- Contribution: Where there are multiple guarantors (often with “joint and several” liability, meaning the creditor can pursue any single guarantor for the full amount), a guarantor who has paid more than their proportional share may seek contribution from the co-guarantors.
How is a valid guarantee formed?
A guarantee, as a contract, requires legal capacity, intention, and consideration. The advance of credit to the principal debtor is sufficient consideration if the guarantee is signed as part of the same overall transaction. If signed later, fresh consideration is required, or the document must be executed as a deed under seal.
Commercial parties must also be aware of statutory formalities:
- Writing Requirement: Under the Statute of Frauds, a guarantee must be in writing and signed by the guarantor to be enforceable.
- Ontario Formalities (ILA): In Ontario, a personal guarantee supported by consideration is generally enforceable without a witness. However, obtaining a Certificate of Independent Legal Advice (ILA) is common practice and strongly recommended, as it adds evidentiary strength and helps preclude a guarantor from later claiming they did not understand the obligations.
- Alberta and Saskatchewan: In contrast, for guarantees executed in these provinces, the guarantor must appear before a lawyer or notary public to execute a prescribed certificate for the guarantee to be enforceable.
Common risks affecting the enforceability of guarantees
Creditors must be careful to avoid unintentionally compromising a guarantee, which can be discharged by operation of law.
The Material Alteration Rule
A guarantee may be discharged if the creditor and principal debtor materially alter the underlying loan agreement without the guarantor’s consent, particularly if the alteration prejudices the guarantor. This rule has been affirmed by the Supreme Court of Canada.
- Waiver is Key: To counter this risk, commercial guarantees commonly contain broad and unambiguous clauses (often referred to as waivers) whereby the guarantor consents in advance to various changes, extensions, or indulgences without affecting their liability.
- Cancellation vs. Amendment: If a lender and borrower subsequently cancel and replace the original loan agreement with a new one, courts may find that the new agreement falls outside the scope of the original continuing guarantee, making it prudent to obtain a new guarantee or confirmation from the guarantor for the replacement facility.
Defenses of the Sophisticated Guarantor
Ontario courts have shown a trend of strictly enforcing guarantees against sophisticated and educated guarantors, particularly officers and directors of the corporate borrower.
- Independent Legal Advice (ILA) is not Fatal: While common practice, the failure of a lender to require the guarantor (who is also a director or officer) to obtain ILA is generally not fatal to the guarantee’s enforceability, as courts assume a degree of business sophistication.
- Non Est Factum: The defense that the guarantor was mistaken about the document’s nature (non est factum) is narrowly available and typically fails if there is evidence the guarantor understood the document or was careless in signing it.
Insolvency and Reinstatement of Rights
Guarantees may be challenged under Canadian insolvency laws (Bankruptcy and Insolvency Act, provincial fraudulent preference/conveyancing laws) if granted at an undervalue or without proper corporate benefit within a certain time before insolvency.
- Clawback Risk: A creditor faces a risk if a payment made by the debtor is later clawed back (set aside) by a liquidator, potentially discharging the guarantor’s liability while the creditor must return the money.
- Reinstatement Clause: To mitigate this, standard Ontario guarantees incorporate a reinstatement of rights clause. This clause automatically reinstates the creditor’s rights against the guarantor as if the avoided payment had never been made.
How can a guarantee be enforced?
For creditors, a guarantee provides an additional and often immediate enforcement pathway.
- Direct and Concurrent Demand: The creditor is generally entitled to make a demand directly against the guarantor concurrently with or before making a demand on the principal debtor. The Ontario Court of Appeal has confirmed that the lender is not required to exhaust its recourse against the debtor or realize on any security before demanding payment from the guarantor, a right often specified in the guarantee itself.
- Nature of Claim: A claim under a guarantee is treated as a claim for a debt rather than damages, meaning the creditor is ordinarily not required to mitigate its loss before enforcing the guarantee.
- Limitations Period: Guarantees governed by Ontario law often explicitly address the Limitations Act, 2002 (Ontario), confirming they are “business agreements” under Section 22 to extend the limitation period to the maximum extent permitted by law.
Final thoughts
Guarantees in Ontario are often signed quickly and later enforced strictly. Clear drafting, especially around waivers of common law protections and the inclusion of clauses addressing insolvency and material change risks, significantly affects the enforceability of the guarantee and the scope of liability that follows.
www.nashid.ca
Daniel Nashid
Barrister & Solicitor
700 Bay Street
Suite 405
Toronto, ON M5G 1Z6