Question. What is the difference between a guaranty of payment and a guaranty of collection? Also, if the guaranty language does not specify the type of guaranty it is how will courts interpret it?
Generally, a guaranty is an agreement or promise to answer for the debt or default of another. A guaranty creates a secondary and not a primary liability, and is only meaningful in relation to, the independent obligation to pay of the primary obligor, and is contingent upon his default. In other words, in the case of a President of a Corporation giving a personal guaranty to a Supplier, it must be shown that the Corporation has failed to make payment before the Corporation’s President will incur any liability.
Thus using our example, a “guaranty of payment” is an unconditional undertaking that the Corporation will pay. On such a guaranty, the Supplier may, upon default, proceed directly against the President, without taking any steps to collect the amount due from the Corporation.
A “guaranty of collection” binds the President to pay only after all attempts to obtain payment from the Corporation have failed. To recover in the case of a guaranty of collection, the Supplier must have reduced its claim against the Corporation to judgment, and an execution returned unsatisfied, or insolvency or other circumstances make it apparent that it is useless to proceed against the Corporation. The exercise of due diligence by the Supplier to collect the debt is a further condition of the President's obligation to pay under a guaranty of collection.
Whether a guaranty is one of payment or of collection depends upon the intention of the parties, as expressed in the agreement. If a guarantor binds himself to pay immediately upon default of the debtor, he becomes a guarantor of payment. A guaranty of “the prompt payment of all obligations of the debtor” and providing that the guaranty shall be a continuing, absolute, and unconditional guaranty of payment is, unequivocally, a guaranty of payment, not of collection.
The Uniform Commercial Code, in dealing with commercial paper, and in making provision for the contract of a guarantor, specifically declares that words of guaranty which do not otherwise specify are to be deemed to create a guarantee payment.