What is a deed of guarantee and what happens if you sign one?

A deed of guarantee is a written contract in which one person, the guarantor, promises a creditor that another person's obligations will be performed. If the person who actually owes the money, the debtor, fails to pay, the guarantor must step in and pay instead. It is called a deed because it is executed with the formalities the law requires of deeds, which gives it a stronger legal status than an ordinary signed contract.

Guarantees most often appear in lending. A bank lending to a small company will frequently ask the owner to guarantee the loan personally, so that if the company cannot repay, the owner can be pursued in their own name. Parents guaranteeing a child's first home loan and a supplier requiring a customer's account to be guaranteed are the same idea in different clothing.

This article covers:

The parties: who is who in a guarantee and what each side promises.
Execution rules: what makes a deed of guarantee validly signed, sealed, delivered and witnessed.
Guarantee versus indemnity: the difference and why it changes your exposure.
Protections: what the law does for guarantors, particularly in consumer credit.
Misconceptions: the mistakes guarantors and lenders most often make.

The three parties and the promise at the centre

Every guarantee involves three people. The creditor (usually a lender) is owed the money. The debtor (usually the borrower) owes it. The guarantor is a third person who promises that the debtor's obligations will be met. If the debtor defaults, the guarantor's own assets are on the line.

The key legal feature is that a guarantor's liability is secondary. The debtor remains primarily responsible, and the guarantor's promise is collateral to the debt. That matters when things go wrong. If the debtor genuinely cannot pay, the creditor looks to the guarantor; if the underlying debt is disputed, the guarantor can generally raise the same defences the debtor could. The guarantor also has a right to be indemnified by the debtor after paying out, although that right is only worth as much as the debtor's ability to repay.

A deed of guarantee is simply a guarantee made as a deed. Lenders prefer this form because a deed is enforceable without proof that the guarantor received anything in return, and because it makes the guarantor's intention to be bound unmistakable. For a borrower's part, being asked for a guarantee is usually a sign that the lender has doubts about the borrower's capacity to repay, and the guarantor is being asked to absorb that risk.

Why a guarantee is usually made as a deed

A deed must satisfy formal requirements that an ordinary contract does not. The classic common law requirements are that it be in writing, signed, sealed and delivered. Two of those requirements have been relaxed in modern Australian law, but understanding them explains the signing ceremony that still surrounds guarantees.

Signing and witnessing

In New South Wales, s 38 of the Conveyancing Act 1919 (NSW) provides that every deed must be signed as well as sealed, and must be attested by at least one witness who is not a party to the deed. That is why the guarantee has a witness signature block, and why the witness must be someone other than the lender or the borrower.

Sealing

The physical wax seal is long gone. Under s 38(3), an instrument expressed to be a deed, or to be sealed, that is signed and attested in accordance with the section is deemed to be sealed. In practice the words "signed, sealed and delivered" in the execution block do the work the seal once did, and no separate sealing step is required.

Delivery

At common law a deed takes effect only when it is delivered, which means the party must intend to be bound by it. Delivery is usually complete when the guarantor signs and hands the document over, so in practice the date of execution is the date the guarantee bites. For companies the position is simpler again: under s 127 of the Corporations Act 2001 (Cth), a company may execute a document as a deed if the document is expressed to be executed as a deed and is signed by two directors, or a director and the company secretary, and delivery is not necessary at all.

Electronic execution

A deed no longer needs paper. Section 38A of the Conveyancing Act allows a deed to be created in electronic form and electronically signed and attested in NSW, and the Corporations Act permits technology neutral signing of company documents. Electronic execution of guarantees is now routine, provided the same witness and attestation rules are followed.

Consideration

Ordinary contracts are only enforceable if each side gives something in exchange. A guarantor typically receives no direct benefit from the loan, which is why the lender's decision to advance the money is usually relied on as the consideration. Making the guarantee a deed removes the argument altogether, because a deed is enforceable without consideration. This is a large part of why lenders insist on the deed form.

Guarantee versus indemnity: a distinction with real consequences

A guarantee is sometimes confused with an indemnity, and the two are often packaged together in a single "deed of guarantee and indemnity". The distinction, discussed by the High Court in Sunbird Plaza Pty Ltd v Maloney (1988) 166 CLR 245, is about the nature of the promise.

A guarantor promises that the debtor will perform: the guarantor's liability is secondary and depends on the underlying debt existing and being enforceable. An indemnifier makes a primary promise to hold the creditor harmless against loss: if the loss occurs, the indemnifier must make it good, regardless of what has happened to the underlying transaction.

The difference shows up most clearly when the underlying contract is defective. If a loan agreement turns out to be unenforceable, a guarantee may fall away with it because there is no debt left to answer for. An indemnity, being a separate promise, may still bind the indemnifier. In commercial lending the two are combined so the lender can rely on whichever promise survives, and the guarantor ends up exposed under both heads. Anyone signing a combined document should understand that they are taking on a primary obligation, not just a backup promise.

A worked example: guaranteeing your own company's loan

Marta runs a commercial cleaning company. The company needs a new van and equipment, so it borrows $80,000 from a bank. The bank is happy to lend, but it requires the company's directors to sign a deed of guarantee and indemnity. Marta signs as a director, personally guaranteeing the company's obligations.

Eighteen months later the company loses its largest contract and stops making repayments. The bank demands payment from the company. When the company cannot pay, the bank calls on the guarantee and pursues Marta personally for the outstanding balance, the accrued interest and its enforcement costs.

Because the loan was made to a company for business purposes, the consumer credit protections discussed below do not apply. Marta's exposure is governed almost entirely by the deed she signed. Her rights against the company, by way of indemnity, are real but worthless if the company has no money. If Marta had negotiated a cap on her liability, or a clause requiring the bank to exhaust its remedies against the company first, her position would be very different. If she had obtained independent advice before signing, she might have been warned that a director's guarantee in this situation is almost always unlimited in amount and duration.

What the law does to protect a guarantor

Where the loan is regulated by the National Credit Code, which is Schedule 1 of the National Consumer Credit Protection Act 2009 (Cth), a guarantor receives a substantial set of statutory protections (the Code). The Code applies to guarantees of obligations under credit contracts where the guarantor is a natural person, and its key protections include the following:

Formalities: Under s 55, a guarantee must be in writing and signed by the guarantor, and it is not enforceable unless it complies. Section 57 requires the credit provider to give the guarantor a copy of the signed guarantee and a copy of the credit contract within 14 days of the guarantee being signed.
Withdrawal: Under s 58, a guarantor may withdraw from the guarantee by written notice at any time before credit is first provided under the contract, or after that point if the final contract differs in some material respect from the proposed contract the guarantor was shown before signing.
A cap on liability: Section 60 makes a guarantee void to the extent that it secures more than the amount of the debtor's liabilities under the credit contract plus reasonable enforcement expenses. The guarantor cannot be pursued for more than the debtor actually owes, whatever the document says.
Court review: Section 76 lets a court reopen a credit contract, mortgage or guarantee that was unjust when entered into, on the application of the debtor, mortgagor or guarantor, taking into account matters such as the relative bargaining power of the parties.
Enforcement sequence: Section 90 provides that a credit provider must not enforce a judgment against a guarantor unless it has first obtained a judgment against the debtor that remains unsatisfied 30 days after a written demand, or unless the debtor is insolvent or cannot be located, or the court has relieved the credit provider of the requirement.

Outside the Code, the courts have developed their own protections. In Garcia v National Australia Bank Ltd (1998) 194 CLR 395, the High Court recognised that a creditor who takes a guarantee from someone in a relationship of trust and confidence with the debtor, such as a spouse or parent, must take reasonable steps to ensure that person understands the nature and effect of the transaction. A guarantee obtained without those steps may be set aside. Courts have also set aside guarantees procured by unconscionable conduct or undue influence.

The important caveat is that these protections cluster around consumer credit. A director guaranteeing a company's business loan is usually outside the National Credit Code, because the loan is for business purposes, and outside the special equity in Garcia, because the relationship is commercial. For a business guarantor, the terms of the deed are the whole game.

Common misconceptions about guarantees

A handful of misconceptions about guarantees are repeated so often they have taken on the ring of truth. The most common are:

"Signing is just a formality": For a director, a personal guarantee converts a company debt into personal debt. Default can lead to judgment, bankruptcy and loss of the family home if it is offered as security. It is one of the most consequential documents a business owner signs.
"The lender has to chase the borrower first": For National Credit Code loans, s 90 does impose an enforcement sequence. But for commercial loans, the deed will usually let the lender demand payment from the guarantor on default without first suing the company. Never assume the lender's remedies are exhausted first.
"It only covers the original amount borrowed": Guarantees commonly extend to interest, fees, enforcement costs and, in the case of continuing guarantees, future advances under an ongoing facility. The Code caps this for regulated credit, but commercial guarantees often do not.
"A verbal promise is good enough": In most states a guarantee must be in writing and signed by the guarantor to be enforceable, a requirement that descends from s 4 of the Statute of Frauds 1677 and now appears in state legislation such as the Instruments Act 1958 (Vic) and the Property Law Act 1974 (Qld). Where the National Credit Code applies, s 55 imposes the same requirement. A deed of guarantee is always in writing, which is part of the point.
"Once the loan is repaid, I am automatically released": Release usually requires the creditor's express agreement. A continuing guarantee can remain on foot through re-draws and renewals, so a guarantor should obtain a written release when the facility ends.
"The bank sets the terms and that is that": Caps on liability, expiry dates, release clauses and requirements to pursue the debtor first are all negotiable before signing, and lenders regularly accept them.

When you need a commercial lawyer's help

A guarantee deserves legal review on both sides of the table, and the point of the exercise is usually negotiation, not just explanation.

For the would-be guarantor, a commercial lawyer will read the deed against the actual loan documents, identify what triggers the guarantee, what is covered, and how the guarantee ends, and then negotiate limits: a cap on the amount, an expiry date, a release on repayment, and a requirement that the lender pursue the debtor first. Where the exposure is unavoidable, a lawyer can advise on alternatives such as offering security over specific assets instead of an unlimited personal guarantee, and on whether the guarantor should seek their own indemnity from the debtor. Independent legal advice also heads off the Garcia-type claims that can arise later if the guarantor did not understand the transaction, which is why lenders routinely ask guarantors to certify that they have received it.

For the lender, a lawyer's role is to make the guarantee enforceable: correct execution so the deed formalities are met, National Credit Code compliance so the guarantee is not void, and careful handling of variations, because restructuring the underlying loan without the guarantor's consent can in some cases discharge the guarantee altogether. The cost of getting these steps wrong is usually a guarantee that cannot be enforced at the moment it is needed most.

The question to answer before you sign

Before signing a deed of guarantee, ask yourself whether you could answer three questions about the document in front of you: what exactly you would owe, when you would owe it, and what would release you from the guarantee. The guarantors who lose the most are rarely the ones who were warned about default; they are the ones who signed an unlimited continuing guarantee for a commercial loan, assuming it was a formality, and discovered too late that it covered interest, costs and future advances with no release clause. If you cannot answer all three questions from the document itself, that is the moment to get advice, because every term that protects a guarantor is a term that must be negotiated before signing, not after.

If you need help with a deed of guarantee, a guarantee and indemnity or any other commercial law issue, contact our team of commercial lawyers for advice on your situation.