Signing a suretyship? Have you become a “surety and co-principal debtor” or a “co-debtor”?
You might have been asked to sign as a surety in your capacity as a director or as a spouse or possibly for a friend who is less creditworthy. This article aims to highlight some of the terminology with reference to a recently decided court case in the Supreme Court of Appeal.
A suretyship agreement is a form of security in favour of a creditor who wants to hold another person (“the surety”) liable in addition to or instead of the actual debtor. The suretyship agreement is accessory to an underlying obligation owed by the debtor to a creditor. Hence, the debtor is also referred to as “the principal debtor”. The purpose of a suretyship agreement is to provide the creditor with security should the principal debtor default on the underlying obligation owed to the creditor. If the principal debtor defaults, the creditor can look to the surety to settle the principal debtor’s obligations.
Insofar as a suretyship is a contractual relationship between the creditor and the surety, the agreement only grants personal rights to the creditor to enforce a claim against the surety in the event of the principal debtor defaulting on the relevant obligation owed to the creditor. This is distinguishable from a mortgage bond for example, whereby the security provided to the creditor entails a proprietary element, thus granting the creditor a real right which it can enforce against the security provider.
The phrase “surety and co-principal debtor in solidum” [“in solidum“ being the Latin denoting that the obligation is for the entire debt] is often found in standard suretyship contracts but recently this phrase gave rise to some debate in respect of the scope of a surety’s liability to the creditor in the recent case of Liberty Group Ltd v Illman 2020 (5) SA 397 (SCA).
It was argued that the phrase rendered the surety in fact a fully-fledged co-debtor [which was the only way the Appellant could overcome the problems it had with the 3 year prescription rule]. In theory however, as mentioned above, a suretyship agreement is accessory to an underlying contract between the principal debtor and the creditor. What this means is that the surety does not have a separate contract of obligation towards the creditor, which would separate the surety’s liability from that of the principal debtor. If this were the case, such separate contract would transform the surety into a co-debtor.
The basic facts of the case were that Liberty Active Ltd (hereinafter “Liberty”) concluded a broking agreement with an independent intermediary, ECE Financial Holdings (hereinafter “ECE”) to sell Liberty’s financial products during 2003. The agreement stipulated that ECE would receive commission on premiums received by Liberty from any clients sourced by ECE. The Respondent, as one of eight individuals, purchased financial products from Liberty through ECE. Each individual signed separate but identical deeds of suretyship in terms of which they bound themselves as “surety and co-principal debtor” for the payment to Liberty of any monies owed to Liberty by ECE. Liberty advanced commission payments to ECE in terms of the broking agreement, on two occasions, but had not received any premiums from the eight individuals by 2011. At that point, the contracts between ECE and the eight individuals, for the provision of Liberty’s financial products, had either lapsed or been cancelled due to the non-payment of premiums by any of the individuals to Liberty. The total amount of the commissions was R1 029 693.50. Liberty ceded its rights to claims arising from the broking agreement to the Appellant in that case, Liberty Group Ltd.
The Appellant issued summons against ECE and all the individuals that had agreed to stand as “surety and co-principal debtor”, for the amount of R1 029 693.50 that ECE owed to Liberty. The Appellant alleged that the effect of the phrase “surety and co-principal debtor” was to transform the sureties into co-debtors, which meant that service of summons on one of the co-debtors would interrupt prescription for the others. Since summons was only served on the Sixth Defendant (the Respondent in this appeal) five years after it was issued, the Respondent would have a valid prescription argument if he was found not to be a co-debtor. Accordingly, the Defendant raised a special plea of prescription to the Appellant’s claim, asserting that the Appellant’s claim was based on the alleged termination of an insurance agreement, five years ago, which claim prescribed after three years of the termination date. The Appellant delivered a replication to the Respondent’s special plea of prescription, asserting that the sureties were in fact co-debtors with the principal debtor and each other, therefore, because summons was served on another surety before the claim had prescribed, the running of prescription in favour of all the co-debtors was interrupted.
The main issue before the Supreme Court of Appeal (hereinafter “the SCA”) was thus whether the phrase “surety and co-principal debtor in solidum” transforms a surety into a co-debtor relationship with the principal debtor and with the other sureties. A second, ancillary but material issue, was whether the service of summons on any of the sureties interrupts the running of prescription in favour of the other sureties. The court of first instance, the Gauteng Division of the High Court, Pretoria, held that the phrase “surety and co-principal debtor in solidum” does not transform a surety into a co-debtor, and therefore dismissed the Appellant’s claim, who then appealed to the SCA.
The SCA considered three previous decisions of that court. For the purposes of this article it is not necessary to discuss to a large extent the court’s evaluation of those three previous decisions. Essentially what the court reasoned, based on the previous cases and the common law, was that “co-debtor” and “surety and co-principal debtor” are two distinct concepts. The court re-iterated that a co-debtor has a principal contract of debt with the creditor, separate from the contracts of other co-debtors. Whereas a “surety and co-principal debtor” remains a surety whose liability to the creditor, and other sureties, is accessory in nature, to the principal contract of debt between the creditor and principal debtor. The effect of the phrase “surety and co-debtor in solidum” in suretyship agreements does not change this position, but merely means that the surety renounces the common law rights of suretyship, being the benefit of excussion and benefit of division.
The benefit of excussion is a surety’s right to require a creditor to first execute fully against the debtor, before pursuing the surety for payment. The benefit of division is a surety’s right to limit her liability to her pro rata share of the outstanding debt in relation to all other sureties; i.e. if there are two co-sureties then each one can only be liable for half of the outstanding debt.
The SCA confirmed that the effect of the phrase “surety and co-principal debtor in solidum” is merely to deprive a surety of these common law rights and that the obligation of such surety has essentially mutated “from an undertaking that the obligation of the principal debtor will be discharged, and if not, that the creditor will be indemnified, to one where the surety assumes the obligation to discharge the principal debtor’s obligation”.
But the phrase does not extend the scope of a surety’s liability to the extent of being a co-debtor, and does not change the nature of the surety’s contract to being anything other than a suretyship agreement.
A suretyship agreement is accessory to a principal contract of debt. Therefore, a surety is only liable to the creditor upon default by the principal debtor. Only at that point does a surety become jointly and severally liable with the principal debtor. “The surety does not become a co-debtor with the principal debtor, nor does he become a co-debtor with any of the co-sureties and co-principal debtors, unless they have agreed to that effect.”
In relation to the ancillary prescription issue the court essentially stated that it is trite in our law that the interruption of prescription against a principal debtor does interrupt prescription against a surety, but the converse does not apply. In other words, interruption of prescription against a surety does not interrupt prescription against other sureties, or against the principal debtor. In this case, prescription was interrupted against another co-surety, but not the principal debtor and therefore prescription in favour of the Respondent, as co-surety, was not interrupted and the defence succeeded. However, a proper understanding of the concept of suretyship could have prevented the Respondent from incurring substantial legal costs and being engulfed in litigation with a big corporate for many years, tying up valuable time and resources. If you are unsure about the content of legal documents and their implications, there is no better alternative than to consult a competent attorney for guidance.
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