This is part three of a three-part series on Contracts of Guarantee.
What is a “Credit Score”?
A “Credit Score” is an indicator of the creditworthiness of a person and indicates their ability to repay a credit facility. It is calculated by algorithms run by Credit Information Companies (“CICs”) based on the repayment history of the person. There are four CICs licensed by the Reserve Bank of India (“RBI”) in India viz, Transunion CIBIL Ltd (“CIBIL”), Equifax Inc, CRIF High Mark Credit Information Services Pvt Ltd, and Experian Credit Information Company of India Pvt Ltd. The Credit Score most accepted by Banks is published by CIBIL. It ranges from 300-900, with 300 being the lowest and 900 being the highest. The higher a person’s Credit Score, the better their ability to obtain a credit facility along with additional perks such as lower rates of interest, better repayment terms, and faster & easier approval processes.
The Guarantor’s checks to avoid poor Credit Scores
Often, Banks insist that a Borrower brings along a person to guarantee the repayment of a loan when the Borrower fails to do so; this is the Guarantor. In law, a Guarantor is liable to the same extent as the Borrower. The Guarantor’s liability to repay the loan arises the moment the Borrower defaults. If a Bank wants the Guarantor to cover costs for default, it must prove that the Borrower failed to make payments. Once this is proved, the Guarantor will be liable for repayment of the defaulted equated monthly installments (“EMIs”) along with the Bank’s applicable penal rates and charges. If a Guarantor also fails to repay the Bank, the Bank can report negative activity by the Borrower as well as the Guarantor to CICs. Thus, the Borrower’s defaults can adversely affect the Guarantor’s Credit Score as well. This will, in turn, impact the Guarantor’s ability to access credit facilities in the future.
To overcome or avoid these kinds of problems, the following are some important points that a Guarantor should be aware of prior to guaranteeing the loan:
- Check the credit history of the Borrower. If possible, they must try to avoid guaranteeing a loan for a person with poor credit history.
- Thoroughly check the fine print of the loan agreement between the Bank and Borrower
- Check the Credit Score of the Borrower across CICs.
- The Guarantor should analyse their financial ability to repay the loan, in case of default by the Borrower.
The Guarantor must also exercise the following care after guaranteeing a loan:
- Regularly keep a check on the Borrower and treat the loan as their own
- Push the Borrower to repay EMIs along with interest on or before the due dates
- Be aware that defaults on EMIs by the Borrower are reflected in the Guarantor’s Credit Score. This may affect their debt-income ratio which can, in turn, minimize their creditworthiness
So how can a Guarantor improve his Credit Score which is affected by an OTS between the Bank and the Borrower?
As explained previously, Banks and defaulting Borrowers sometimes enter into one-time settlements (“OTS”). While it may seem like a relief to the Borrower, it adversely affects their Credit Score, because, when a loan is settled, it is viewed as a negative credit behavior by lenders. The Guarantor’s Credit Score appears also to be affected by the OTS. However, we have previously stated that a Guarantor may be protected by section 133 of the Indian Contract Act. If a Guarantor’s Credit Score is negatively impacted by an OTS, they can take one of the following steps:
- Repay the amount written off by the Bank. After repaying the written off amount, the Guarantor may raise a dispute on the CIC’s portal. The Guarantor may seek removal of negative remarks in the dispute. The Guarantor can separately seek a refund of the written off amount from the Borrower. This is explained further below
- The Guarantor may have the right to seek removal of the negative remarks on the basis that they have been discharged due to the variance between the Bank and Borrower without his consent. For this, the Guarantor may raise a dispute on the CIC’s portal.
In either of these cases, the Bank and CIC have to take steps to remove the negative remarks. If the Bank and/or CICs do not remove the negative remarks, the Guarantor may file claims against them. The claim that may be brought against Banks and CICs includes correcting the incorrect credit report and may also include a claim for tortious defamation. The procedure for bringing claims against Banks and CICs upon their failure to address a valid dispute is prescribed by section 18 of The Credit Information Companies (Regulation) Act, 2005. This issue is dealt with in a future post.
How can a Guarantor seek refund from the Borrower?
When a Guarantor chooses to repay the written-off amount to the Bank, they do so on behalf of the Borrower. Once repaid, the Guarantor is permitted to “step into the shoes” of the Bank and take over the Bank’s rights. This is known as subrogation. It is a legal doctrine, which can arise either as a matter of law or by agreement. The purpose of subrogation is to prevent one person from unjustly benefitting at the expense of another. Whether subrogation arises by law or by agreement depends on whether the guarantee is written or oral.
In written guarantees, the Guarantor is protected by sections 140 to 145 of the Indian Contract Act, 1872. These rights are:
- Right of the Guarantor upon payment or performance of the guarantee: When a Borrower defaults in payment, the Guarantor must pay all the defaulted EMIs. After payment, the Guarantor has the same rights that the Bank had against the Borrower.
- Right of the Guarantor to security: The Guarantor is entitled to exercise the same rights over the Borrower’s security that the Bank had.
- Right of recovery: The Guarantor is entitled to recover the entire sum paid to the Bank on the Borrower’s default. The law takes the view that there is an implied promise by the Borrower to repay the Guarantor all the sums the Guarantor has correctly paid.
Where the guarantee is not in writing, the Guarantor is still protected in law, under sections 69 and 70 of the Indian Contract Act, 1872 as follows:
- Right of reimbursement: When a Guarantor pays on behalf of a Borrower, the law recognizes that the Guarantor is entitled to be reimbursed by the Borrower. The law does not permit the Borrower to take undue advantage by (a) failing to repay the Creditor; and (b) failing to reimburse the Guarantor when they make a payment.
- Right to compensation for performing a Borrower’s obligation: The law protects a person who does anything on behalf of someone, which he did not intend to do gratuitously. The person who enjoys the benefit will be liable to compensate the person performing the obligation.
Therefore, a Guarantor has rights under in law. They can avail of those rights whenever they repaid the EMI of a defaulting Borrower. This can resultantly improve the Credit Score of the Guarantor.