In the modern credit marked, there is an extensive usage of guarantees, from both businesses and consumers. It has been important for legislator to ensure that the guarantors have had a good enough foundation to assess both the risk relating to the possibilities of the guarantee being called upon and that the conditions for executing the guarantee in the first place are applicable throughout the lifespan of the guarantee.
The Financial Contracts Act section 66 (hereinafter “the section”) regulates a financial institution’s right to release a mortgaged property or other security that was furnished or that was assumed would be furnished when the guarantee was executed, i.e. when the guarantee contract was entered into. If a financial institution does not comply with the section, then the guarantor will no longer be bound by the guarantee.
The section’s first paragraph, first sentence, provides the main rule, that the guarantor has to expressly consent to a release of the furnished or assumed furnished security provided. An implied consent or consent ascribed to a passive behavior is not enough due to the term “expressly“. The Act’s preparatory works specifies that the consent have to be in writing for it to be deemed “expressly”. Some legal scholars argues that a written consent is not required. However, given the statements in the Act’s preparatory work, a financial institution who wants to be on the safe side, should seek out a written consent from the guarantor when releasing a security.
The main rule is not absolute and the section’s first paragraph, second sentence lists up certain exceptions to the main rule. A financial institution has the right to release the initial security if another security is furnished which is at least as satisfactory for the guarantor as the security being released. Furthermore, a financial institution may also release the initial security given if the release is of no significance or very limited significance for the guarantor’s position.
The first exception allows for a replacement of the original security for another security. The condition is that the new security being furnished is at least as good as the original security. Furthermore, the new security has to be established when the old security is being released at latest. The Act’s preparatory works expresses that when evaluating if a security is equally satisfactory, one have to perform an attentive evaluation based on the knowledge that is available at the time of releasing the relevant security. Nonetheless, a foreseeable development of the security’s quality in the remaining lifespan of the guarantee must also be taken into consideration. If a new security decreases in value within a near future, than the replacement is inadequate. In addition, the monetary value of the security is not the only aspect that needs to be evaluated when deciding if the security is as least as good as the previous security. There also has to be an evaluation on the new security’s attributes in a potential recourse. If the new security is more difficult to enforce and realise, then the new security is not a satisfactory replacement.
Even if there is no security replacing the released security, a financial institution still has the opportunity to release the security provided, if the release no significance or very limited significance for the guarantor’s position.
The questions then arises as to what this qualification implies. The Act’s preparatory works lists some examples to illustrate when a release of security has no significance or very limited significance for the guarantor’s position. One example may be when a lender accepts to relinquish the security for a small area of a very large agricultural property. In this example, the value of the security has not been deteriorated, because the release of security only concerned a fraction of the value of the estate. In such cases the release of the security has no consequences for the guarantors standing and the exception is applicable. In other words, the exception is only applicable when the guarantor’s risk of the guarantee being called upon is not increased with the release of the security. Another example that the Act’s preparatory works points out, is the situation whereby the wording of the guarantee itself calls for the guarantee to be called upon before the security granted in such regard may be enforced, and the guarantor does not have the opportunity to claims for recourse against the relevant security issuer.
If the exceptions as stated above are not applicable, then the guarantor has to consent to a release of the security. Such consent may only be given in connection with the imminent release of the original security. A financial institution may therefore not contractually include clauses in their contracts allowing the financial institution to release any given security whenever they want. This however only applies to consumers. According to section 2 of the Financial Contracts Act, section 66 yields to a contract, established practice between the parties or other custom or practice that is regarded as binding between the parties.
If a financial institution releases any security contrary to the provision of section 66, first paragraph, then the question arises what consequences such a release may have. The consequence is according to section 66, second paragraph that the guarantor is no longer bound by the guarantee. The contract between the guarantor and the financial institution ceases to exist, and the financial institution can no longer claim any rights pursuant to the guarantee.
The same will apply if a security had be explicitly assumed furnished, but is never established. The guarantor will in these situations be relieved from the responsibility the contract provided.
The Financial Contracts Act section 66 therefore protects a guarantor from releases or other changes to securities that leads to a greater risk for the guarantor than when the guarantee was executed.
A financial institution will often rely heavily on guarantees given as security for a loan. The lack of a guarantor may often result in the borrower not being granted a loan. If a loan is granted and a guarantor has agreed to execute a guarantee, then there are rules set in place to safeguard that specific guarantor. If a financial institution releases security without consent from the guarantor, it can result in financial consequences for the financial institution. They may be left without any security in connection to the loan. It is therefore important that banks and other financial institutions are aware of the demands drawn up in section 66 and the rest of the Financial Contracts Act.