LOAN GUARANTEE AGREEMENT

What is a loan guarantee?

Loan guarantees are promises by a third party that a loan will be paid in full, even if the original borrower defaults. The third party may be an individual, a business, or even a government entity.

The purpose of the loan guarantee is to assure that the lender can extend loans, even in periods where economic conditions are not favourable for all types of borrowers.

What does it involve?

Loan guarantee sometimes involves the pledge of a business to pay off the balance of the loan in the event that the debtor is not able to do so.

One example of this type of arrangement involves a subsidiary and a parent company. The subsidiary obtains a loan from a local banking institution, with the provision that the parent company will guarantee the amount of the loan, and settle the debt in the event that the subsidiary is sold, or is closed by the parent.

Kinds of Loan guarantee:

There are two kinds of loan guarantee:

Guarantee of payment.

Guarantee of collection.

Things included in a loan guarantee agreement:

Collateral security: The borrower may pledge assets as security for a loan. Such an arrangement often involves only two parties: the borrower and the beneficiary.

Letters of credit: A letter of credit is a promise by the issuing bank to pay a specified amount to the beneficiary when the borrower defaults on the loan.

Co-Guarantors: In some cases the beneficiary may require more guarantee coverage of the primary obligation than any one guarantor will agree to provide.

Subrogation

Subrogation: Another key provision of the guarantee concerns subrogation. Subrogation provides for one party (in this case the guarantor) to stand in the shoes of another (the beneficiary), giving the substitute the same legal rights as those of the original party, For example, subrogation allows the guarantor to “stand in the shoes” of the beneficiary, allowing the guarantor to assume and exercise the beneficiary’s legal rights against the primary obligor (or other sources of credit enhancement for the loan).

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