What Is A Cross Guarantee?
Cross guarantee refers to a legal agreement between two or more parties who agree on being liable for each other’s debts or obligations through the creation of a network of guarantees. The main purpose of the cross-guarantee is to increase creditworthiness plus provide an extra layer of security to the lenders for their loans.
Borrowers can take advantage of others in the cross guarantee to access larger amounts beyond individual capacity at good terms. Nevertheless, it poses a great risk to the creditworthiness of the entire guarantors if any of them fail to pay the loan. Before entering into such arrangements, one must take into account due diligence regarding repayment capacity.
Table of contents
- A cross guarantee entails a legal agreement among multiple parties, wherein they mutually accept liability for each other’s debts or obligations by establishing a network of guarantees.
- The primary objective of a cross-guarantee is to enhance creditworthiness and offer an additional layer of security to lenders who provide loans.
- Therefore, this arrangement compels multiple borrowers to collectively guarantee each other’s obligations or debts.
- Hence, the deed of cross-guarantee establishes a mutual guarantee arrangement among multiple entities, ensuring joint responsibility for liabilities and obligations.
Cross Guarantee Explained
Cross guarantee refers to an arrangement between firms related to each other or within a group for taking on the responsibility of fulfilling each other’s debts and obligations through reciprocal guarantee. Hence, a single creditor becomes the creditor for a host of related companies within the cross-guarantee. As a result, the borrowing entities enjoy better interest rates and affordable terms of the loan, and longer duration of repayment.
Moreover, a lender receives an extra advantage due to the customary inclusion of an indemnity clause in the guarantee. As such, the agreement gets treated as an indemnity bond for the lender by the courts, thereby making it disadvantageous to the borrowers.
In addition, the lender has the power to enforce the guarantee despite holding the principal borrower’s asset as security. Therefore, the collective responsibility of the borrowers gives them bargaining power in terms of loan terms, rate of interest, and larger loan value. However, participant of the cross-guarantee loses their autonomy.
These agreements have legal implications as they may be challenged in court by the lender in case of default. Furthermore, the cross guarantee agreement has different structures per the hierarchy in the group. Furthermore, they have two types:
- Direct agreement: makes every entity directly guarantee the debts and obligations of the other.
- Indirect agreement: makes a central entity give the guarantee of fulfilling the loan obligation of the others
Finally, every entity must enter into the guarantee only after ascertaining the repaying capacity of the other, as it may dent their image if others default.
Deed Of Cross Guarantee
Deed of Cross Guarantee concerns a legal document establishing mutual guarantee arrangement within multiple firms or entities. Hence, it ensures joint responsibility for the liabilities and obligations of each other by every member entity. Therefore, a layer of financial security gets added to all parties, reducing their overall risk. The deed contains the outline of the scope plus the extent of the guarantee and types of guarantees like contracts, loans, or any other financial commitments.
Moreover, the deed also defines the roles and respective responsibilities of the entities involved. It also clarifies the situation under which the guarantee will get activated, like in case of non-repayment or default by any party. Thus, other parties must handle the repayment shortfall if any partner entity fails to fulfill its loan obligation. It also acts as a cost-sharing mechanism for distributing the loan costs incurred and the amount to be contributed by each for the same in equal values.
Therefore, after signing the deed of cross agreement, entities of the credit consortium reflect their commitment towards protection and support to each other. Furthermore, it is imperative for all the entities signing the deed of cross guarantee to read and understand it carefully to ensure the enforceability and effectiveness of the act. Moreover, the silver cross guarantee does not reflect the security of the cross, and that cross guarantee template having a deed of cross guarantee checklist is readily available with the lawyers and online portal.
Let us use a few examples to understand more about the topic.
Example # 1
Let’s consider a scenario where two small businesses, namely On Deck and Lendio, seek a bank loan to expand their operations.
However, the bank is still determining the creditworthiness of each business individually due to its limited operating history.
Hence, to address the bank’s concerns, both firms agree to provide a cross-guarantee. In this arrangement, On Deck Co. guarantees the loan obligations of Lendio Co., and Lendio Co. guarantees the loan obligations of On Deck Co.
Besides, if one company defaults on the loan, the bank can seek repayment from the other company. Therefore, the cross guarantees provide the bank with additional reassurance that there is a collective responsibility and an increased likelihood of loan repayment.
Thus, this arrangement allows businesses to access the financing they may have yet to be able to secure individually.
Example # 2
Canon Australia Pty Ltd has been one such entity that used cross guarantee to secure its loan through a legal arrangement. The cross guarantee involved mainly Canon Australia Pty Ltd, its parent company, Canon pty ltd., its other subsidiaries, and banks through contractual agreements to act as guarantors to secure the loan taken by Cannon Australia Pty Ltd. As a result, it helped bolster investors’ & stakeholders‘ confidence, mitigated risk, allowed financial stability, and strengthened the company’s operations.
Cross Guarantee vs Cross Default
Let us use the table below to understand the differences between the two:
|Here multiple borrowers come together to guarantee each other’s obligations or debts.
|Cross default means a clause in the loan contract where default from any party triggers default by all other parties.
|It enables higher loan amounts to ineligible borrowers.
|Therefore, it protects from default even by any party involved in the agreement.
|Lenders get more security for their loans from multiple parties.
|Even though different borrowers have different credit liabilities, default by anyone becomes the default of everyone.
|The risk of loan amount gets equally distributed amongst guarantors increasing overall financial stability.
|These gets embedded in the original loan agreement showing the consequences of loan default.
|This clause has to be signed separately by the parties besides the main loan agreement.
|These get embedded in the original loan agreement showing the consequences of loan default.
Frequently Asked Questions (FAQs)
It simply establishes an arrangement of cooperative mutual guarantees between different partner entities. As a result, each entity ensures that they are equally responsible for the other’s obligations and liabilities. Moreover, it also helps the lender secure its loan given to the partners from default and turning to loss.
Every partner must consent to revoke the deed of cross guarantee. It gets done by:
· Drafting revocation amendments to the original deed
· Making clear statements of intention to end the arrangement
Finally, the legal consultant must be brought in to finalize the revocation per the general laws and contractual obligations.
Multiple entities that work together to secure an acquisition or complete a project need a cross-guarantee to obtain huge capital from lenders. In such cases, these entities sign the deed of the agreement, taking responsibility for each other’s obligation & liabilities towards the loan. Thus, they ensure the safety of the loan and timely repayment of the loan to the lender and avail loan at reasonable terms.
It has many benefits:
· This provides shared credit responsibility within the entities.
· Building and strengthening confidence in stakeholders, creditors, and investors
· Risk Reduction
· Smoothening out of the business relationship
· Providing an extra layer of security to the creditors
· Giving reliability and stability to the lender
This has been a guide to what is Cross Guarantee. Here, we explain the topic in detail including, its deed, examples, and comparison with cross default. You can learn more about it from the following articles –