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Associate Mikk Läänemets writes about the liability of sureties based on a Supreme Court judgment

19.05.2010

According a recent case decided by the Estonian Supreme Court, the conclusion of several contracts of suretyship does not necessarily mean that the creditor has the entire debt secured. Before concluding a contract of suretyship, it should be carefully considered whether a contract should be concluded with several persons, whether the maximum amount of suretyship should be fixed, and whether the obligations secured could be regarded as a single obligation in the particular case. Otherwise, the creditor may find itself in a situation where the obligations secured are regarded as a single obligation, in which case sureties have solidary liability but the liability is limited to the maximum amount fixed in the contract concluded with them. This may mean for the creditor that, instead of the full debt, only a half of the debt is secured.

Concluding a contract of suretyship is a common way of securing the performance of contractual obligations. Contracts of suretyship are most frequently entered into to secure loan or other monetary obligations. Under a contract of suretyship, the surety undertakes to be liable to the creditor for the performance of the principal debtor’s obligation.

A suretyship is, by its nature, a kind of security whereby the security provider assumes solidary liability. Therefore, if the principal debtor has breached one of its obligations (e.g. has failed to perform a monetary obligation to the seller of goods or services), the principal debtor and the surety are, as a rule, solidarily liable for the performance of the obligation. This means that the creditor may require performance of the obligation secured by the suretyship from both the principal debtor and the surety. A surety is liable for the obligation secured by the suretyship in full. This means that, in addition to the obligation to pay the principal amount, the surety is also liable for the consequences arising from non-performance, in particular for payment of fines for delay, contractual penalties and compensation for damage, and for compensation for expenses relating to withdrawal from or cancellation of the contract.

It is common practice to sign contracts of suretyship with several persons in order to gain greater protection against possible non-performance. Often separate agreements with different sureties are entered into to secure the performance of a specific monetary obligation or monetary obligations that are severable. It is useful for both the creditor and the principal debtor to have several sureties, for if the principal debtor and/or one of the sureties should turn out to be insolvent, for example, the creditor may simply bring its claim against the second or third surety.
There is often confusion about the extent of suretyship, i.e. the amount of the monetary obligation secured by the suretyship. Namely, § 150 of the Law of Obligations Act stipulates that if one and the same obligation is secured by several persons, i.e. co-sureties, such persons are solidarily liable to the creditor even if they do not undertake the suretyship together (e.g. if a separate contract of suretyship was concluded with each surety). 

A recent judgment of the Civil Panel of the Supreme Court, dated 13 April 2010, also concerns issues relating to the extent of the liability of co-sureties. The judgment pertains to a case where a seller had sold forestry and repair equipment to a buyer, with the price being payable by instalments, and had concluded separate contracts of suretyship on the same terms and conditions with two different persons. Both sureties undertook to secure the performance of the buyer’s obligations under the contract of sale up to the maximum amount of 1.2 million EEK. The buyer was of the opinion that the thing sold to it did not conform to the contract and, for that reason, did not perform its payment obligation arising from the contract of sale in the manner and to the extent agreed upon. The seller, thereafter, withdrew from the contract and requested that the sureties pay the principal amount, interest, a fine for delay, and a contractual penalty (in a total amount of approximately 2.4 million EEK). In the opinion of the seller, the liability of both of the sureties under the contract of suretyship was 1.2 million EEK and, therefore, the total amount of the claim that could be brought against two sureties was 2.4 million EEK. The surety lodging the appeal with the Supreme Court, however, was of the view that the total liability of the sureties was limited to 1.2 million EEK since they secured the same obligation. The Supreme Court held that, in the case in question, the sureties had secured the same obligation to the same extent under the contracts of suretyship and, according to § 150 of the Law of Obligations Act, their solidary liability to the seller was limited to the amount agreed upon, i.e. 1.2 million EEK.

Based on the Supreme Court judgment, it can be concluded that claims arising from a contract of sale (i.e. the principal amount, interest, and contractual penalty) should be treated as a single obligation. Thus, if a person wishes to secure all of these claims by, for example, two contracts of suretyship, both sureties should secure the obligations of the principal debtor in full. Taking the Supreme Court case as an example, this would mean that the buyer should have found two sureties both of whom were willing to secure the obligations of the buyer not to the extent of 1.2 million EEK but to the extent of 2.4 million EEK.

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