Personal Guarantee for Loans

Q: My Family Farm Corporation has applied for a loan from Farm Credit Canada.  They are asking for a personal guarantee for the loan from me and my husband.  They told us that we have to each speak to a lawyer to get independent legal advice for the guarantee.  Why is this necessary?

A:  The short answer to this question is “to make sure that they can enforce the guarantee.”  Often times when an individual or corporation is unable to get a loan on their own from a lending institution, the lending institution will ask for a guarantee from someone else who has the ability to pay (the guarantor).  A common example is a parent guaranteeing a loan for their child to purchase their first automobile. 

Usually, both parties to a contract receive some benefit.  The bank collects interest on their loan and the child gets access to funds for the purchase of a vehicle.  The guarantor, however, often doesn’t get any benefit, but takes on a lot of risk.  The parents don’t get the car or any interest on the loan, but are on the hook if their child defaults.  The courts in Canada have been very strict with how lending institutions treat these guarantors.  In many cases, the guarantor has a close personal or professional relationship with the borrower.  Because of that relationship, the courts have to make sure that the guarantor hasn’t signed a guarantee because of undue influence (strong pressure) from the borrower. 

The courts have imposed a duty on banks and other lending institutions to investigate and ensure guarantor hasn’t been unduly influenced by the borrower or any other interested party.  If they suspect that the guarantor has been pressured, the bank has an obligation to ensure that the guarantor receives independent legal advice.  If they don’t, the guarantee might not hold up in court.  It would be impractical and expensive for a bank to investigate every loan.  Not surprisingly, lending institutions have adopted the policy of requiring every guarantor to obtain independent legal advice.

The purpose of independent legal advice is to ensure that the guarantor is providing their informed consent to guarantee the loan.  A lawyer - who has no stake whatsoever in the loan agreement, representing neither the bank nor the borrower -  must carefully go over the agreement with the guarantor.  This must be done without the borrower or lender present.  The lawyer must explain what the guarantee does, what could happen if the borrower does not pay, and all of the risks being assumed by the guarantor.  The must make sure that the guarantor fully understands what they are signing.  The lawyer must feel confident that the guarantor is not under strong pressure or undue influence from the borrower.  It is not the job of the lawyer to provide business advice on whether or not the loan is a wise idea, just to make sure that the guarantor understands what they are signing.  Once the certificate of independent legal advice is complete, the bank can rest easy that if the loan goes south, they can still collect from the guarantor.

This article first appeared in the publication “The Western Producer,” and is reprinted with permission.