What to do when a borrower absconds loan repayment
Standing as a guarantor is not wrong. But make sure you know what you’re getting into.
Imagine this, your friend wants to buy a car worth Sh1.5 million, she doesn’t have the full amount, so she decides to take a loan.
After going to the Sacco or bank, she finds she doesn’t have enough security, so she asks you to be her guarantor, and you agree. After all, she is your friend and you trust her, right?
Two years later you get a call from the lender about a loan that isn’t being serviced, you’re puzzled because you don’t have a loan, but they remind you that you agreed to be a guarantor for your friend’s loan.
So, what can you do, after the borrower you guaranteed defaults on making the agreed-upon payments?
A guarantor is a person who promises to settle a borrower’s debt if the borrower defaults on their loan obligation.
As a guarantor, if you don’t want to get into trouble for helping a friend secure a loan, it is important to understand the consequences of the obligation. It is the duty of the guarantor to repay the loan if the borrower fails to pay it back.
If you are already a guarantor, keep in touch with the borrower informally and regularly and make sure that the loan repayment is happening smoothly. Guarantors usually place their shares and deposits as well as other personal assets as collateral against the loans, so they will be used to cover the loan.
Most defaults are not intentional and happen due to difficult financial circumstances. One can only take precautions against such eventualities.
If you have guaranteed a loan and the borrower defaults, here is what you can do:
Check if the borrower has deviated from the original agreement
Every loan agreement between a bank/Sacco and borrower comes with terms and conditions. These include the rate of interest, payment terms, and pre-payment liabilities. If any of these terms get altered during the loan tenure, the guarantor’s liability goes away. This is because the guarantor wasn’t involved in the negotiations between the lender and the borrower.
In the case Holme-vs-Brunskil (1878) 3QBD, it was stated that “if there is any agreement between the principals with reference to the contract guaranteed, the surety ought to be consulted, and if he has not consented to the alteration…” What this means, in effect, is that the guarantor may be discharged from a guarantee where there has been a variation of the original facility to which he has not been privy and has not consented.
Check for exit clauses in the agreement
Guarantors don’t have much say in negotiating with a bank for having exit clauses while agreeing with the borrower and lender.
However, the law protects the guarantor from exploitation, and one can negotiate for such a clause to be introduced in the agreement before execution.
Request the borrower to replace you as a guarantor
Replacing a guarantor during the term of a loan is possible. Requests for replacing a guarantor mainly arise if there are disputes between a borrower and the guarantor or the economy is slowing down, leading to the probability of rising loan defaults.
In the event a guarantor wishes to withdraw from guaranteeing a borrower’s loan before the loan matures, he/she is required to request the borrower to replace them with another member as a guarantor.
Have an indemnity agreement with the borrower
If you end up paying the borrower’s dues after she defaults, how will you recover your money?
As a precautionary measure, you must enter into an indemnity agreement with the borrower.
An indemnity agreement is a legal contract between two parties where one party agrees to compensate the other party for specific losses or damages that may occur due to certain actions or situations. The purpose of an indemnity agreement is to protect one party from potential financial losses arising from legal claims, damages, liabilities, or expenses that may arise out of a particular transaction, service, or relationship between the parties involved.
It’s however important to note that an indemnity agreement entered into after the borrower opts for the moratorium may not stand the test in a court later because it could be proved that the borrower may have signed the indemnity under pressure.
The Law of Contract Amendment Bill (2023) intends to shield the assets of such guarantors, requiring that all lending institutions, including Banks and Saccos, first go for the defaulter’s properties, including shares or unpaid dividends/rebates, before targeting those held by a guarantor(s). This also applies to when the borrower dies.
Becoming a loan guarantor is a significant financial responsibility and involves certain risks. Before agreeing to become a guarantor for a loan, here are several essential steps and considerations to take into account:
- Understand your responsibility as a guarantor: Fully comprehend the role of a guarantor. As a guarantor, you are legally responsible for repaying the entire loan amount if the borrower defaults.
- Review the loan terms: Obtain and carefully read through the loan agreement and terms. Understand the specific conditions, interest rates, repayment schedule, and any clauses related to default and the guarantor’s obligations.
- Assess the Borrower’s Creditworthiness: Evaluate the borrower’s ability to repay the loan. Assess their financial stability, credit history, income, and any other factors that might affect their ability to fulfil the loan obligation.
- Assess your own financial situation: Determine if you can afford to repay the loan in case the borrower defaults. Assess your financial stability, income, and existing liabilities to ensure you won’t face significant financial hardship in the event of having to repay the loan.
- Know the exit strategy: Discuss with the borrower and understand their repayment plan. Additionally, have a clear plan on how you can be released from the guarantor obligation in the future (such as loan repayment milestones, refinancing options, or specific conditions for release).
- Seek legal or financial advice: Consult with a financial advisor or lawyer to understand the legal implications and ensure you fully comprehend the terms of the guarantee.
- Communicate openly: Have open and honest discussions with the borrower about their financial situation, the reason for needing a guarantor, and the expectations regarding repayment.
- Consider alternatives: Instead of being a guarantor, explore alternative ways to help the borrower, such as co-signing with less financial risk or providing other forms of assistance.
- Documentation: Ensure all agreements are documented properly. If you decide to proceed, make sure to get copies of all relevant loan documents and agreements.
Remember, agreeing to become a guarantor should not be taken lightly. It’s crucial to thoroughly assess both your own financial situation and the borrower’s ability to repay the loan before making any commitments. If in doubt or if you’re uncomfortable with the terms, it might be best to decline the request to become a guarantor.
Standing as a guarantor is not wrong. But make sure you know what you’re getting into. A reduction in income or a job loss can hurt anyone – a borrower or even a guarantor. It’s important to assess the repayment capacity of the person you are standing for as a guarantor. If the default probability is high, avoid standing in as a guarantor. If you still have to, make sure an indemnity agreement is signed and is water-tight.