Why surety bonds often fail—and how to structure them so they protect the creditor
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You have an agreement with a guarantor – are you sure that they will actually be liable if the debtor does not pay?
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Did you know that if a company’s management changes, the current director’s guarantee may no longer apply to new obligations?
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What should be included in a surety agreement so that it truly protects the creditor, rather than creating the illusion of protection?
A lender issued a loan to a legal entity. The agreement included a director’s guarantee. The company stopped making payments. The lender filed a claim against the guarantor.
The guarantor responded: the demand was not filed on time; notice was not sent within three months of the delay. Civil law releases the guarantor if the creditor fails to file the demand within the prescribed period after the delay occurred.
The creditor didn’t know this rule. The guarantor didn’t pay.
What is a surety?
A surety is an agreement under which the guarantor undertakes to be responsible to the creditor for the debtor’s fulfillment of their obligation. The guarantor provides additional guarantee for the debt’s repayment. If the principal debtor fails to pay, the creditor has the right to turn to the guarantor.
Surety is regulated by Articles 1692-1720 of the Civil Law of Latvia.
Four conditions of a valid surety
Condition one: written form. The surety must be in writing. An oral surety has no legal force. This is a mandatory requirement of the law.
Condition two: a clear definition of the scope of liability. The agreement must specify the specific obligations the guarantor guarantees, the amount, and the period. The guarantee may be limited (principal only) or full (debt + interest + penalties + collection costs). If the scope is not defined, the court will interpret it restrictively.
Condition three: joint and several liability. By default, the guarantor bears subsidiary liability—meaning that they can only be approached after the impossibility of collecting from the primary debtor has been proven. If you want to be able to make a claim against the guarantor immediately, explicitly state in the agreement that the liability is joint and several.
Condition four: the time limit for filing a claim. Article 1715 of the Civil Code: the guarantor is released from liability if the creditor fails to file a claim against them within three months after the due date for the principal obligation. Unless a different time limit is specified in the contract, you have three months from the date of the delay to contact the guarantor.
A real case
The company entered into a long-term supply contract. The guarantor was the director and sole shareholder of the purchasing company. The contract was valid for three years. Then the company stopped paying, accumulating a debt of 28,000 euros.
The creditor filed a lawsuit against the guarantor. He stated: “I acted as guarantor as a director. A year ago, I sold my stake in the company and resigned as director. My authority ceased. The company’s new obligations arising after my departure do not concern me.”
The court partially agreed: liability for obligations incurred during the surety’s term remains. No liability for new obligations. The creditor received part of the claim. If the surety agreement had explicitly stated that it extended to all obligations under the agreement, regardless of a change in management, the situation would have been different.
What must be written down
First: a direct indication that the liability is joint and several—the creditor has the right to contact the guarantor at the same time as the debtor.
Second: the scope of liability - the principal debt, interest, penalties, collection costs.
Third: the term of the guarantee is not tied to the position or status of the guarantor, but a specific date or “until all obligations are fully fulfilled.”
Fourth: the procedure for notifying the guarantor of the delay with a specific deadline.
Fifth: an arbitration clause - if you want a quick process if collection is necessary.
Three steps to take now
First: find all surety agreements - check whether the scope of liability, the type of liability (joint and several or subsidiary), and the deadline for filing a claim are specified.
Second: if there is already a delay in payment under any agreement and three months have not passed, immediately send a written demand to the guarantor.
Third: When entering into new contracts with a surety, consult a lawyer to draft this section. A weak surety is worse than no surety at all—it creates a false sense of security.
Just because the guarantor signed doesn’t mean they’ll pay. They’ll only pay if the contract is properly drawn up.
This article is for informational purposes only and does not constitute legal advice.