Can You Enforce All Your Guarantees?

When entering into a franchise agreement with a corporate franchisee, it is common practice for the franchisor to require a director or shareholder to provide a personal guarantee. Thereby acting as security to ensure the franchisee company meets its obligations, in particular its obligations to pay fees. A recent case highlights the care required to ensure that such guarantees are enforceable.

Background English courts have historically come to the aid of guarantors where it is perceived that the guarantor was not aware of the full implications of signing the guarantee.

For some time now, the courts have raised a presumption of "undue influence" where a party to a bank loan (whether a guarantor or a mortgagor) seems to have no commercial connection with the transaction. Typically, this might be a wife acting as guarantor or allowing the family home to be mortgaged as security for her husband's business in which she has no direct interest. In such instances, the courts will usually require proof that the wife has been independently advised and knew full well the obligations she was signing up to. If the beneficiary of the guarantee/mortgage cannot show this, they will often be unable to enforce their guarantee / mortgage.

The Yardley case The High Court recently looked at lease guarantees in the case of The Trustees of Beardsley Theobalds Retirement Benefit Scheme v. Yardley. The circumstances of the case were extreme. One of the tenant's directors deliberately concealed from Mr Yardley, an employee (and former director), that he was signing a guarantee, rather than simply witnessing a signature. As a result, Mr Yardley's guarantee was held to be unenforceable and the landlord was left without a viable party to sue. The tenant was already insolvent.

Lessons to be learned In order to make sure that a personal guarantee is enforceable, the Yardley case suggests a number of key items that must be checked or considered.

Does the guarantor have a legitimate interest in signing the guarantee? The courts would be surprised to see a mere employee give a guarantee, but not a director or shareholder.

If the guarantor is referred to as being a director or shareholder of the corporate franchisee, has this been independently verified? This check should be repeated just before the guarantee is signed.

Even if the guarantor seems to have a legitimate interest in giving the guarantee (for example, the wife of the principal operator who is also a...