15 March 2023
Corporate Newsletter – March 2023
Corporate Guarantee in Commercial Deals – The Do’s and Don’ts
Indonesian Civil Code categorises ‘guarantee’ as one of the forms of security to ensure performance/fulfillment of certain obligations or engagements (in Bahasa “perikatan”) such as debts, payment obligations. Guarantee would normally be granted by individual.
Along with the development of business arrangements, the scope of ‘guarantee’ has effectively been expanded to meet the business needs. These days, it is not uncommon to encounter guarantee given by corporation guaranteeing the performance of certain obligations; for example, parent company guaranteeing the performance of its subsidiary(ies).
This newsletter is aimed to discuss the concept of corporate guarantee (in relation to commercial deals) under Indonesian laws especially the do’s and don’t’s in providing corporate guarantee.
What kind of transactions require a corporate guarantee?
The needs to provide corporate guarantee goes back to the commercials between the parties to the arrangement rather than regulatory requirement (save for stock exchange related transactions).
Examples of transactions which would normally require corporate guarantee:
- Loan arrangement where the debtor’s parent company possesses the assets which can be placed as security of the loan.
- Technology provision arrangement where the technology provider has yet to possess strong financial standing to showcase the ability to perform contractual obligations.
- Service arrangement where the service provider lacks of strong financial standing to serve substantial size of project requiring its service.
- Procurement arrangement where the product provider (whose product will be procured) lacks of sufficient capital to ensure timely delivery of the products.
- Any arrangement where the counter party require corporate guarantee to establish assurance that the contracutual obligations will be performed.
Who can be the guarantor under a corporate guarantee?
To satisfy the needs of providing corporate guarantee, it is key to ensure that the guarantor will be able to perform the obligations guaranteed by the guarantor.
The rule of thumb would be to ensure that the guarantor has equal economic interest as the parties to the commercial arrangement.
As an example, in a loan arrangement, the parent company of the debtor would have equal economic interest as the debtor as the financials of the debtor would eventually be consolidated into the parent company’s financials and therefore default will effectively affect the parent company.
Determining the guarantor is key in establishing the corporate guarantee as this may impact the execution of the corporate guarantee and eventually securing the interest of the parties to the arrangement.
The do’s in providing corporate guarantee.
Key matters to be considered when providing a corporate guarantee:
- Determining the appropriate guarantor of the corporate guarantee. Please refer to the previous section discussing the ‘how’ when determining the guarantor.
- Performing sufficient due diligence to establish the needs of corporate approval(s) in relation to the provision of the corporate guarantee. Corporate guarantee may lead to disposal of assets or undertaking obligations under material contract(s) and the Articles of Association of the guarantor may categorise these as material transaction(s) requiring approval(s) such as shareholders’ approval. In this case, it is pivotal to secure such corporate approvals in advanced to avoid potential hurdles in executing the corporate guarantee in future.
- Defining the obligations to be guaranteed by the corporate guarantee. As the corporate guarantee will need to cover specific obligation(s), it is important for the underlying commercial arrangement to define and set out the obligations which will be guaranteed by the corporate guarantee. Although there is no prohibition or restriction of the scope of a corporate guarantee, narrowing down the scope of the corporate guarantee will eventually ensure clear execution mechanics and avoid misinterpretation of what should be delivered by the corporate guarantee. For example, under service agreement arrangement, to ensure the service provider delivers the service it would be relevant for the corporate guarantee to specifically cover the provision of such services rather than the entirety of the service agreement which may include other provisions in addition to the services related provisions.
- Establishing clear and measurable trigger for corporate guarantee to be exercised. The triggering event of corporate guarantee to be exercised shall be clear and measurable to avoid dispute caused by misinterpretation. For example, in a loan arrangement, ideally the corporate guarantee should not be invoked on the first day of delay of payment. There should be clear mechanics of non-payment even after a specific remedy period being given and mechanics of how to invoke the corporate guarantee to be exercised by the creditor(s).
- Setting up clear mechanics of the deliverables under the corporate guarantee. What is expected to be delivered/performed/covered by the corporate guarantee should be clearly described under the underlying arrangement. A corporate guarantee may assume the agreement which is under default due to non performance, or the corporate guarantee shall ensure the obligations under such agreement to be performed within certain period.
The don’t’s in providing corporate guarantee.
The following should be avoided when providing/entering/requiring corporate guarantee to be placed:
- Unclear trigerring event and the mechanics of execution.
- Lack of corporate approval(s).
- Unclear/unverified identity of the guarantor.
- Invalidity/unenforceable of the underlying arrangement. As the corporate guarantee existence is dependent to the underlying arrangement, it is important to ensure the underlying arrangement is valid or enforceable before the laws. Unenforceability issue may lead to corporate guarantee being invalid.
Limitation of liability is an important aspect which should be considered by the guarantor. Essentially, each legal entity assumes its own legal personality and capacity, and default of a party related to the guarantor should not be considered as the guarantor’s default.
This limitation must be clearly addressed in the corporate guarantee documentation.
MURZAL & PARTNERS
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