May a corporation guarantee the repayment of the debt of another corporation? A corporation has applied for a loan with a bank but it has insufficient collaterals. To supplement the security, the corporation submitted the guaranty from another corporation. Should the bank accept such guaranty as additional collateral? This is a difficult business judgment call for the bank.

                The general rule is that no corporation has the power, by any form of contract or endorsement, to become a guarantor or surety or otherwise lend its credit to another person or corporation. Such use of its credit is clearly beyond the power of an ordinary business corporation. If there will be an exception, it can only be based on the justification that the guaranty is in furtherance of the business of the corporation.

                The Securities and Exchange Commission has taken the view that the power to enter into suretyship agreements and to issue corporate guarantees must be provided for in the articles of incorporation; otherwise, any such suretyship or guaranty may be considered ultra vires, and will make the concerned members of the board personally liable to the stockholders (SEC Opinion dated April 16. 2008). Even if so provided in the articles, the corporation still has to show that the suretyship or guaranty will be in furtherance of the business purpose.

                For example, if the corporation guarantees the loan of its president which was applied for to benefit the corporation, the guaranty may be considered allowable. Also, ifa corporation owns and controls another, the former may guarantee the debts of the latter. However,the mere fact that there are common stockholders does not necessarily authorize one corporation to guarantee for the other. The common denominator is that the guaranty is issued to obtain some benefit for the guarantor. There is no hard and fast rule in this regard and each case must be measured against its own peculiar facts and circumstances (Herbosa and Recalde, Revised Corporation Code, p. 170).

                The issue then is whether the business of the surety or guarantor corporation has been so enhanced by the suretyship or guaranty. But even when there is a possible benefit to the corporation, the risks can be considerable and the benefit can be remote, intangible and difficult to evaluate. Where it is sufficiently remote or disproportionate to the risks, the courts have held the guaranty unenforceable (De Leon, Corporation Code, p. 332). Additionally, there is vulnerability to legal challenges from creditors and minority stockholders alleging undue liens and undue disposition of assets.

                Related thereto, the SEC has issued opinions on mortgages executed by a corporation on its assets to secure the obligation of another corporation. These are based also on the same rationale applicable to suretyships and guarantees, namely, (a) that the mortgage is in furtherance of the interest of the corporation and is done in the usual and regular course of its business; or (b) that it is made to secure the debt of a subsidiary. For its validity, certain points should also be considered, such as: that there is pertinent authority of the corporation under its articles, that the purpose of the security is legal, that it will not hamper the continuous operation of the corporation, and that the parent company is solvent and capable of paying the creditor (Herbosa and Recalde, ibid., p. 171). The main issue still is whether the security arrangement is beneficial to the corporation.

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The above comments are the personal views of the writer. His email address is [email protected]