Guarantees

• The systems of guarantees allow the financial institution to reduce the risk that the enterprise it is granting a loan to would be incapable of facing up its obligations of repayment.
• These guarantees may be in two forms:
  • personal guarantees: one or more natural persons or legal bodies commit(s) to undertake the borrower's obligations in case of default. That mechanism is called surety.
  • securities: a personal or real property is left to the lender as guarantee, or designated as such in a contract or notarised instrument. According to the terms of guarantee and nature of the property, this will be called mortgage, pledge or lien.
• The Surety
• The Mortgage
• The Lien
• The Pledging

The Surety

The surety is a contract by which a natural person or legal body (company) commits towards a creditor to perform the obligation of a debtor if the latter does not do so.

A legal entity can stand bail only if its articles of association authorise so.
Several persons can stand bail for the same obligation.

In principle, the person standing bail can claim:
- the beneficum discussionis: it can compel the creditor to sue the main debtor prior to turning against it;
- the beneficum divisionis: if several people stand bail, each of them can demand that the repayment charge be distributed among them.

However the financial establishments may introduce in the surety contract a clause of undivided ownership and a clause of joint and several liability. These clauses allow them to turn against only one debtor for collecting the whole of the debt.

The guarantor repaying a debt has a "right of subrogation": it takes over the debt and all the guarantees that were vested into the credit establishment.

Advantages:

The surety is often indispensable to get a loan.
The surety does not necessitate the release of monies.

Utilisation:

The surety is used for short-term credits as well as for long-term credits.

The most concerned long-term credit is the investment credit. As a matter of fact within the framework of the leasing, the fact that the lender remains owner of the property is in itself a guarantee.

It is much more unusual to find a surety mechanism for quasi-capital, except for some subordinated loans.

Risks:

The natural person or legal entity standing bail can be compelled to settle the debt if the enterprise is not able to face up its obligations.

The Mortgage

The mortgage is a mechanism by which a real property (e.g.: a house) is offered as guarantee of the repayment of a loan.

The debtor can continue to use the property throughout the term of the loan. In case of problem of repayment, the creditor may attach the property and proceed to its putting up for sale.

Mortgaging takes place generally speaking before a public notary and will be entered in an official register.

Advantages:

It is an usual form of guarantee within the framework of an investment in real estate.
A mortgage does not necessitate releasing funds.
The creditor keeps the usage of the property.

Utilisation:

Mainly in the case of investments in real estate (warehouses, commercial or industrial buildings, farms,...) : it is thus the property the acquisition of which is financed by the loan that will be mortgaged.

A real estate can however be mortgaged as surety for another debt.

Risks:

If the enterprise cannot face up its obligations, the mortgaged property will be put for sale.

The Lien

The lien is a mechanism by which a personal good (e.g.: a car) is handed over by the borrower to his creditor as surety for the payment of its debt.

The creditor acquires the ownership of the good and should see to it that it is correctly preserved.
The debtor gets the good back when the debt is repaid.

Personal property may be intangible. They can for instance be debentures, like bonds or shares. In such case however only a percentage of the value of the securities will be taken into account. Such percentage will depend on the "risk" associated to the securities. The certificates of deposit will be taken into account for 100% of their value, Government bonds for 80% and listed shares for only 60%.

Advantages:

The pledging, especially of securities, only brings about few costs both for the bank and for the borrower.

Utilisation:

The lien is often used as guarantee mechanism for short- or long-term loans.

Risks:

The debtor might loose the pledged property in case of problem of payment.

The Pledging

The pledging is a mechanism by which a personal property is affected to the guarantee of a loan but remains in the debtor's hands.

Since the borrower is not dispossessed of the property, an official document is generally necessary to verify the pledging.

The pledging can concern capital goods, goods, or even trade debts.

A business can also be given as pledge, but the guarantee for the lender is not so good. As a matter of fact if the enterprise experiences difficulties causing it not to meet its commitments towards the creditor, the value of its business will also be affected thereby.

Advantage:

The enterprise remains in possession of the pledged good.

Utilisation:

Pledging is often used as guarantee tool within the framework of investment credits. It is the financed capital good that will be pledged.

Risks:

In case of problem of payment, the pledged good will be taken back by the creditor.

Guarantees required by the Development Finance Institutions

Most financial institutions require guarantees from the beneficiaries of loans, especially:

• personal guarantees from the directors and owners of the enterprise;
• pledging of securities;
• mortgages (within the framework of the financing of real estate projects);
• pledging of the financed capital goods.

Some institutions demand also guarantees for the mezzaninefinancing.

Guarantees given by the Development Finance Institutions

The DFI's when proposing bank guarantees, propose in fact to stand bail for the borrower. Such guarantee facilitates the access to credit, because besides the guarantee itself, the presence of a recognised institution reassures the moneylenders on the seriousness of the project.

European bilateral institutions:

• These institutions propose to guarantee the long-term loans of enterprises, but the minimum guaranteed amounts exceed largely one million EUR.

European regional institutions:

• The EIB offers guarantees for long-term loans.

African regional institutions:

• All these institutions propose to guarantee long-term loans, some by means of special funds set up to this end.

Multilateral institutions:

MIGA is a specialist of the guarantee formulae of investment projects in developing countries. Rather than the traditional bank guarantees, MIGA proposes guarantees against the specific risks. It is more a system of insurance than guarantees within the strict meaning of the word.

• restrictions to exchange operations: MIGA offers guarantees against the situations where the government of the investment country limits the exchange operations (but does not cover the risk of devaluation);
• expropriation by a government (in case for instance, of nationalisations);
• war and civil unrest : the investments are guaranteed in case of destruction or damage, even in case of terrorist acts.