10 - Conventional Security: Cautionary Obligations

Summary

GENERAL

Concept of a cautionary obligation

‘A cautionary obligation or guarantee is granted by way of security for the fulfilment of some primary obligation on the part of a principal debtor, who, as such, remains liable.’ There are, accordingly, at least three parties involved with any cautionary obligation: a creditor; a debtor; and a cautioner.

Cautionary obligations often relate to debts owed by a debtor, such as a sum due under a bank loan. It is also possible to create cautionary obligations in respect of the performance of non-monetary obligations. All insolvency practitioners, for instance, are required to provide a bond of caution.

Dependent and independent obligations

There is generally no distinction between the terms ‘guarantee’ and ‘caution’. In English law, a cautioner is sometimes known as a ‘surety’. Not all agreements that carry the label ‘guarantee’ are cautionary obligations in the technical sense. Cautionary obligations arise where an agreement is accessory to, or dependent on, a principal obligation. Sometimes a document that is called a ‘guarantee’ is so drafted that it is, in form, a principal obligation whereby the guarantor becomes a principal obligant with the principal debtor.

The distinction between a cautionary obligation and a separate principal obligation depends on the proper construction of the obligation, since they are almost invariably in writing. An important factor is whether the parties intend the second obligation to be conditional on the debtor's breach of the principal obligation. If so, the second obligation is cautionary; if they do not, it is a separate principal obligation. Labels do not matter. A purported cautionary obligation that mentions the principal debt generally but is otherwise ‘totally unconnected’ with the existence or extent of that principal debt will likely be considered independent rather than cautionary. In practice, the classification of an obligation as a cautionary obligation or as a separate principal obligation will often depend on the particular facts of the case, making an abstract test quite difficult.

The courts will consider whether the terms of the agreement are consistent with a cautionary obligation. This may be the case, for example, because of an exclusion of the cautioner's common law privileges, such as its rights of recourse, or by specifically derogating from the rule that the cautioner's liability can be no greater than that of the principal obligation.