What Happens to a Surety When the Principal Debtor Is Insolvent?
If you have signed as surety for a principal debtor and that debtor is sequestrated or liquidated, the creditor’s right to claim from you remains fully intact. This is one of the most misunderstood aspects of suretyship in South African law and one of the most financially devastating surprises a director can face.
In South African law, liquidation applies to companies and close corporations, while sequestration applies to individuals. Both can act as principal debtors, and both can sign as surety in their own right. A company can bind itself as surety for the debt of another entity, just as an individual director can bind himself personally for a company’s debt. In either case, the underlying obligation to repay does not disappear simply because insolvency proceedings have begun.
Understanding Suretyship: The Accessory Nature of the Obligation
Suretyship is a contract in which a surety agrees to be liable to a creditor for the debt of another (the principal debtor). Under South African common law, suretyship is an “accessory” obligation, meaning it is tied to the existence of the principal debt.
The general rule is straightforward: if the principal debt is legally extinguished (e.g., paid in full or settled), the surety’s obligation falls away. This leads many directors to assume that once a company is liquidated, the “debt” is gone, and their personal liability ceases.
That assumption is incorrect.
It is critical to understand that liquidation or sequestration does not “extinguish” the principal debt. It simply changes how that debt is administered. The company’s debts survive the insolvency process, which exists to manage the distribution of remaining assets to creditors.
As confirmed by the Supreme Court of Appeal in BOE Bank Ltd v Bassage 2006 (5) SA 33 (SCA), the liquidation process does not discharge the surety’s indebtedness.
What Happens When the Principal Debtor Is Sequestrated or Liquidated
When a company is placed in liquidation, or an individual is sequestrated, the creditor has two avenues available. It can prove a claim against the insolvent estate and receive a dividend, or it can pursue the surety directly for any outstanding balance. Oftentimes, it will do both.
The surety remains fully liable for the shortfall
The surety’s liability only reduces by whatever the creditor recovers from the insolvent estate. If the liquidation dividend covers 30 cents in the rand, the surety remains personally liable for the remaining 70 cents. There is no automatic write-off of the balance simply because the company no longer exists.
This position is reinforced by the Insolvency Act 24 of 1936. Section 120(3) of the Act expressly provides that a composition between a creditor and an insolvent debtor does not affect the liability of any surety for that insolvent estate. The legislature has been deliberate in protecting creditors’ rights against sureties even when the principal debtor’s obligations are restructured or settled.
The benefit of excussion
Some suretyships include the benefit of excussion, which means the creditor must first exhaust its remedies against the principal debtor before pursuing the surety. However, many commercial suretyships expressly waive this benefit, as was the case in BOE Bank v Bassage. If you have waived excussion, the creditor can come directly after you without first proving what it recovered from the insolvent estate.
Get Advice on Your Suretyship Liability
Suretyship liability is a serious personal risk that does not disappear when a company is wound up. If the principal debtor is sequestrated or liquidated, you remain exposed for any amount the creditor cannot recover from the insolvent estate.
At Cawood Attorneys, we have extensive experience advising directors and business owners on their rights and obligations in insolvency proceedings. If your company is under financial pressure or you are concerned about your exposure as a surety, contact us for a confidential consultation.