 Hello, it's Waylon Chow and this is Secured Lending Module 5, Part A. In this part we will explain what is an unsecured loan and what are the issues arising from making an unsecured loan. We will also look at guaranteed loans and guarantees and also various issues arising from guarantees. Let's try to understand the problems that may arise from making an unsecured loan, or in other words a loan that does not involve any collateral. So using a simple example involving me and you over there. So one day I am a bit short of cash and I ask, may I borrow some money for lunch? And you are very kind and say, yeah sure, here's 20 bucks. So the 20 bucks goes over to me and I thank you and I promise to pay you back next week. So I take that money and I spend it on my lunch. Next week rolls around and I say I am sorry, I just can't pay you back. So you are not very happy about that and you are very upset actually and you say I will sue you. And I respond, go ahead, I don't care. Now you are correct that you do have a right to sue me to try to recover that 20 dollars. But the difficulty you face is that litigation or suing someone is uncertain, lengthy and costly. Uncertain in the sense that no matter how strong your case may be, you never know if you will win or lose in court. It is also lengthy. The litigation process can take quite a long time. Sometimes it can take years before a case makes it to trial. And it is also costly, especially if you have hired a lawyer to assist you in your case. So there will be significant legal fees involved. So here is a more general description of an unsecured loan. So we have a debtor here who can also be known as the borrower, but we will try to be consistent with our terminology here and always call the borrower the debtor. So a debtor can be any business or individual. The creditor also known as the lender can be a bank, could be a supplier that is selling to you on credit, or it could be a finance company. With an unsecured loan, money is lent or credit is extended from the creditor to the debtor. And the debtor in exchange makes a promise to repay the amount of money that's been loaned. And on default, the creditor may sue the debtor to try to recover the money that's been loaned. To manage the risks of making an unsecured loan, a lender may require one or both of two things, a guarantee and or a security interest. A guarantee essentially makes a third party liable if in case the borrower defaults on the loan. A security interest gives a creditor a right on default to seize an asset owned by the borrower in order to repay the loan. A guarantee loan is just like an unsecured loan, except now we have a third party involved that we call a guarantor. A guarantor can be anyone, it could be a friend or a relative, or quite often it could be the shareholder of a corporate debtor. So if a corporation is trying to borrow money, one of the shareholders, especially a primary shareholder, could be asked to be a guarantor. The guarantor enters into an agreement with the creditor promising to pay the debt if the debtor fails to do so. So with the guarantee, the third party promises to pay the debt in case of default by the debtor. A very typical example is where a corporation is applying for a loan from a bank. So this is usually a new corporation starting out with a new business. As a new business, the corporation likely has very few assets, no track record of earnings. And the lender, the bank, will more often than not want a personal guarantee from the principal shareholder of the corporation. So the effect of that is that if the corporation defaults on the loan, the bank can ask the principal shareholder to pay the loan. So the principal shareholder will be personally liable for the loan. A guarantor can be relieved of liability under a defaulted loan. If they can show that there was an increase in the risk of default that was not consented to by the guarantor themselves. So this could include situations such as the debt contract, the loan was varied to increase the amount of debt or the interest rates. So this increase in the debt or the interest rate was not consented to by the guarantor. If that's the case, the guarantor would not be liable. Another situation where the risk has been increased without consent is where the creditor breaches the debt contract in a way that affects the guarantor's risk. So an example of this is where the creditor initiates enforcement proceedings before they are actually allowed to under the terms of the contract. Another situation is where the creditor does something that reduces the value of the debtor's collateral. So if the loan was secured by some collateral provided by the debtor and that the creditor did something to reduce the value of that collateral, then the guarantor would not be responsible. For example, if the collateral was something perishable like pork bellies and when the creditor took over possession of these pork belly collateral and they did not think to put them into a refrigerator and they all went bad, then the guarantor can say, look, you didn't take care of the collateral, I shouldn't be held liable for the loss of the value of that collateral. And also if the creditor breaches some term in the contract of guarantee itself, the guarantor can use that as the basis for being relieved of liability. The courts have said that a guarantee may be invalid or unenforceable if the guarantor did not understand the nature of the obligations being undertaken. In other words, the guarantor did not understand the serious nature or the specific legal responsibilities that they would have by signing the guarantee. Because of that concern, there is a requirement that any guarantee contract has to be in writing in order to be enforceable. And we touched on that when we were talking about the formation of contracts back in Module 2.1. And also because of the concern to make sure that guarantee is enforceable, it's usually a good idea to have the guarantor obtain independent legal advice from a lawyer before they actually sign the guarantee. And if there is a situation where there's a loan default and the guarantor has had to pay money under the guarantee to the creditor, the guarantor is then entitled to be reimbursed for that money from the debtor.