A guarantor often assumes their obligation is secondary, that a lender must first chase the borrower before turning to them. A recent Sri Lankan Supreme Court decision, DFCC Bank PLC v. Vithanage Happawana (SC/CHC/Appeal No. 34/2017), shows this assumption can be dangerously wrong. Accepting and signing as a guarantor is not a mere legal formality, it is a real commitment with real consequences.

The dispute in question

The dispute in question arose when a borrower defaulted on a loan and instead of first pursuing the borrower, the bank sued the guarantor directly to recover the debt.

The legal position

The Court noted that in Sri Lanka, banking and surety matters are governed by Roman-Dutch Law, the residual law of the land, read alongside English law. Under both systems the general rule is that a guarantor becomes liable only after the principal debtor fails to perform, and the debtor should normally be pursued.

However, the Court observed that where a guarantee clause states that the guarantor accepts liability as a principal debtor and may be sued without the lender first proceeding against the borrower, that waiver is valid and binding. The guarantor cannot later insist the lender go after the borrower first.

The guarantor in this case had signed a guarantee which contained such waiver. The Court held that the bank was entitled to proceed directly against him once the debt fell into default. The familiar defence of not being aware of the contents of the document was not accepted by the Court as the said defence should only be applicable where the signatory was illiterate or lacked the mental capacity to understand the terms.

Key takeaways

1. A guarantee is a real commitment, not a formality.

People often sign guarantees simply to help a friend, relative or business partner obtain a loan, trusting the borrower and skimming the terms in the rush for approval. The document binds you all the same.

2. It strengthens a lender’s ability to recover.

Rather than writing off a defaulted debt or waiting out lengthy proceedings against the borrower, lenders can include clauses that let them pursue the guarantor directly and recover sooner.

3. Understand the clause before you sign – and take legal advice.

Whether you sign as a shareholder, an investor or for someone close to you, accepting such a clause means your own assets may be used to repay a defaulted debt. Once you have understood and signed, there is no going back to argue you did not understand. Borrowers should make their guarantors aware of these terms, and lenders should draft them clearly to avoid disputes.

Conclusion

The decision sits comfortably with wider precedent. In India, State Bank of India v. M/S Index Port Registered (1992) likewise held that a creditor need not exhaust the mortgaged property before proceeding against a guarantor. While the outcome may seem rigid on guarantors, it brings credibility and predictability to commercial lending, confidence for creditors, and a clear reminder for anyone standing as a guarantor to understand exactly what they are signing.

This is a landmark judgement on the importance of guarantor clauses in financial lending, and on the need for care both in drafting those clauses and in reading them before signing.