In this video, I explain suretyship and guarantor as it is covered on the CPA exam.
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Suretyship and guarantee are two distinct concepts in financial transactions, involving three parties: the creditor, the principal debtor, and either a surety or a guarantor.
Surety: A surety is someone who agrees to fulfill the debt or obligation of the principal debtor directly to the creditor. The key aspect of a suretyship is that the surety is immediately responsible for the debt if the principal debtor fails to pay. This means the creditor can directly demand payment from the surety without first having to seek payment from the debtor.
Illustrative Example: Consider a scenario where David borrows $15,000 from Emily with a repayment deadline of July 1st. Frank acts as a surety for this loan. On July 1st, if David fails to repay, Emily can directly approach Frank for the repayment. Frank is liable for the debt, irrespective of whether Emily has tried to get the payment from David first.
Guarantor: In contrast, a guarantor's responsibility is conditional upon the debtor's default. The guarantor promises to fulfill the debtor's obligations only if the debtor fails to do so. The creditor must first attempt to collect the debt from the principal debtor before they can demand payment from the guarantor.
Illustrative Example: In a different scenario, David borrows $15,000 from Emily with the same repayment deadline. This time, Frank guarantees the loan. Here, if David doesn't pay by July 1st, Emily must first exhaust efforts to collect from David before she can ask Frank to pay. Frank's obligation to pay only arises if David defaults and Emily is unable to collect the debt from him after reasonable attempts.
Additionally, there's a special type of guarantor known as a "guarantor of collectibility." This person is only liable if the creditor cannot collect the debt from the debtor after all legal methods (like demand, lawsuit, judgment, and all other legal proceedings) have been exhausted. This adds an extra layer of security for the guarantor, as their liability is only triggered after extensive efforts to recover the debt from the principal debtor have failed.
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