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Taking Care of Business Law

Mar 2, 2017

Joint and Several Liability: Importance of a Contribution Agreement

In the context of a closely-held corporation, it is often the case that a lending institution will require joint and several guarantees of the shareholders before any funds are advanced to the corporation. If one of the guarantors pays the guaranteed debt, that guarantor will have an implied right to obtain contribution from the non-paying guarantors. The right of the paying guarantor to obtain contribution from the non-paying guarantors is founded on the principle of unjust enrichment. However, the equitable contribution is subject to a number of restrictive rules which may give rise to consequences that were either unintended or unforeseen by the guarantors. For instance, a guarantor's right to obtain contribution does not arise until a guarantor has paid more than his or her rateable share of the guaranteed debt. Absent a contract, the guarantor's rateable share of the guaranteed debt will be based on the number of guarantors, irrespective of the fact that the guarantors may be receiving unequal benefits from the guaranteed obligation, whether as a result of unequal shareholdings in the borrower corporation or otherwise. So, if there are five guarantors who have provided joint and several guarantees, the share of each guarantor would be 20% of the shortfall. The paying guarantor would not be able to obtain contribution from other guarantors until the paying guarantor has paid more than 20% of the shortfall. 

Before the guarantors agree to provide their guarantees, the guarantors should carefully consider how they intend to apportion liability amongst themselves in the event a demand is made on their guarantees. The allocation of liability can be dealt with in a contribution agreement or as a component of a shareholders agreement. Otherwise, the guarantors may find themselves paying more than their fair share of the guaranteed debt than what they had originally intended.

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Keywords

shareholders  |  agreement  |  Business  |  liability

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