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Rights Of A Guarantor To Recover Payment Of Guaranteed Debt






 In a loan arrangement, apart from securities, a borrower is also typically required to have a third party provide guarantee(s) in favour of its creditor (guarantor). This would serve to provide assurance and comfort to the creditor as a guarantor assumes the responsibility for the debt under the loan arrangement in the event the borrower defaults on payment of the loan or if the borrower’s business folds.


However, would a guarantor be able to recoup his losses upon payment of the guaranteed debt and what are the rights afforded to guarantors under Malaysian law?


This alert discusses the rights of a guarantor under statutory law to recover amounts paid under a guarantee, specifically on the right of subrogation.


Introduction To Guarantee


A contract of guarantee is essentially a contract to perform a promise, or discharge a liability, of a third person in case of his default. It may be made either orally or in writing.


Under a contract of guarantee:


(a)“guarantor” or “surety” refers to the person who gives the guarantee.


(b)“principal debtor” refers to the person in respect of which default the guarantee is given.


(c)“creditor” refers to the person to whom the guarantee is given.


The liability of a guarantor is the same as that of the principal debtor unless the guarantor and the debtor otherwise agree. A surety under a continuing guarantee will be liable for the full amount due as the guarantee is not given in respect of a specific amount but rather it continues to remain in existence during the term of the loan.


Rights Of Guarantor To Recover Payment Of Guaranteed Debt


Under the Contracts Act 1950, a guarantor is endowed with the following rights:


(1)Right of recoupment - right to claim the amount from the principal debtor upon payment or performance of all that he is liable for under the guarantee pursuant to Section 93 of the Contracts Act 1950.


(2)Right of subrogation – right to every security which the creditor has against the principal debtor at the time when the contract of guarantee is entered into (regardless of whether the guarantor knows of the existence of such security), upon payment or performance of all that he is liable for under the guarantee pursuant to Section 94 of the Contracts Act 1950.


(3)Right of contribution – where there are two or more guarantors for the same debt, right to claim equal contribution from a co-guarantor pursuant to Section 99 of the Contracts Act 1950.


(4)Right of indemnification – where the principal debtor has expressly agreed to indemnify the guarantor, the guarantor has a right to sue on such agreement pursuant to Section 77 of the Contracts Act 1950.


Right Of Subrogation


The right of subrogation is a right to take the creditor’s place in relation to its security over the principal debtor and its priority in the insolvency of the principal debtor. A guarantor may enforce the rights of the creditor and otherwise deal with the security as it sees fit. In short, the guarantor steps into the shoes of the creditor.


The guarantor is not only empowered to seek financial redress directly against the principal debtor, but may, under certain circumstances, use the name of the creditor to obtain indemnification for the losses sustained, or the advances made, from the principal debtor.


What Happens If A Creditor Loses Or Parts With The Security?


Pursuant to Section 94 of the Contracts Act 1950, in the event the creditor loses or without the consent of the guarantor, parts with the security, the guarantor is discharged to the extent of the value of the security.


In addition, Section 92 of the Contracts Act 1950 provides that if a creditor does any act which is inconsistent with the rights of the guarantor, or omits to do any act which his duty to the guarantor requires him to do, and the eventual remedy of the guarantor against the principal debtor is thereby impaired, the guarantor is discharged.


In the case of United Overseas Bank (Malaysia) Bhd v Tan Chong Whatt & Ors [2022] MLJU 1148, the High Court examined the duty of a secured creditor to take prompt action to realise its security where the debtor has been wound up and the consequences for failing to do so on the guarantors’ obligations as principal debtors and indemnifiers under the guarantee.


In this case, following the winding up of the borrower, the plaintiff (who was the creditor) had issued a letter of demand to the borrower in respect of the amounts due under the facility agreement up to the winding up date.


Subsequently, the plaintiff had also issued letters of demand to the defendants (who were the guarantors), demanding for a significantly higher amount which encompassed not only the amounts due under the facility agreement up to the winding up date but also for further interest that had accrue post winding up date.


Upon winding up of the borrower, the liquidator had sold a charged asset under the loan and the same was used for the settlement of the outstanding amounts owing to the plaintiff. The plaintiff did not retain the excess sale proceeds from the charged asset for the benefit of the defendants. Subsequently, the other securities were re-assigned and discharged by the plaintiff to the liquidator.


The High Court held that the plaintiff had wrongfully agreed to release all securities to the liquidator upon receipt of the full redemption sum without regard to the defendants’ rights of subrogation and as such, the defendants were discharged as guarantors by reason of Sections 92 and 94 of the Contracts Act 1950 and were released from any liabilities under the guarantee.

From the case, it appears that a creditor owes a duty to the guarantor to ensure that their right of subrogation would not be impaired and if the creditor fail to do so, the guarantor may be discharged from all liabilities under the guarantee.


Distinction Between Subrogation And Assignment


In the case of Progressive Insurance Bhd v Ministry of Defence Malaysia & Ors [2021] MLJU 2497, the High Court discussed the distinction between the concept of subrogation and assignment. Reference was made by the High Court to the Insurance Law by MacGillivray & Parkington (7th edition) which explained the distinction between the two concepts in the context of insurance. Although both subrogation and assignment permit one party to enjoy the rights of another, it was well established that subrogation is not a species of assignment.


The rights of subrogation vest by operation of law rather than as the product of express agreement whereas the rights of subrogation can be enjoyed by the insurer as soon as payment is made, as assignment requires an agreement that the rights of the assured be assigned to the insurer. 


Another distinction lies in the procedure of enforcing the rights acquired by virtue of the two doctrines. An insurer exercising rights of subrogation against third parties must do so in the name of the assured whereas an insurer who has taken a legal assignment of his assured’s rights under statute should proceed in his own name.


Conclusion


Guarantors are afforded various rights and avenues to recover their losses from the principal debtors under the Contracts Act 1950, provided that such rights are not contracted away by the parties. In respect of the right of subrogation of guarantors, it is prudent for the creditors to take steps to ensure that the guarantor’s rights to the securities under the loan agreement are preserved.


13 September 2023





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