Key Takeaways

  • A collateral promise is a secondary agreement where one party agrees to be responsible for another’s obligation, often requiring a written contract to be enforceable.
  • It differs from an original promise, which creates a direct obligation and does not always require written evidence.
  • Courts often examine whether the promise is made to benefit the promisor personally (original) or solely to guarantee another’s debt (collateral).
  • Under statutes of frauds, collateral promises usually must be in writing, though exceptions like promissory estoppel may apply in limited circumstances.
  • Businesses must carefully structure collateral agreements to avoid unenforceability, disputes, and unintended liabilities.

A collateral promise is one that is established by statute. A promise established aside from the legal statute is referred to as original. These terms have been introduced by case law to ease contract interpretation. The original promise creates debt because it establishes a quid pro quo relationship. On the other hand, a collateral promise can be a binding contract but does not create debt.

Distinguishing Original and Collateral Promises

Although these terms are not clearly defined in legal terms, they were initially adopted to indicate which cases fall outside or inside a statute as intended by Parliament. Remembering this distinction can help you discern that an original promise does not necessarily constitute priority and a collateral promise is not necessarily conditional.

Let's look at some case law examples provided by Chest of Books.

  • D'Wolf vs. Rabaud: "The terms original and collateral promise, though not used in the statute, are convenient enough to distinguish between the cases where the direct and leading object of the promise is to become the surety or guarantor of another's debt, and these where although the effect of the promise is to pay the debt of another, yet the leading object of the undertaker is to subserve or promote some interest or purpose of his own."
  • Roser v. Roser: "Admitting there were a promise; yet it being collateral it did not make a debt, but should have been brought as an action upon the case."
  • Ambrose v. Rowe: "Rolle's argument in that case of Sands c. Trevilian not promises as distinguished from debts are always promises to be answerable only on default of a principal debtor, there seems no reason to doubt that an absolute promise of a surety to pay the debt of one who received the quid pro quo and who also was absolutely liable, is a collateral promise, with reference both to the action of debt and to the Statute of Frauds."

Common Situations Involving Collateral Promises

Collateral promises are frequently used in both commercial and personal contexts. Some examples include:

  • Loan guarantees: When a third party assures repayment if the borrower defaults.
  • Business transactions: A supplier agreeing to deliver goods based on a third-party guarantee of payment.
  • Lease agreements: A company officer guaranteeing the lease obligations of their business.
  • Service contracts: An individual promising to cover the cost of services rendered to someone else if that person cannot pay.

These examples demonstrate how collateral promises provide an additional layer of security, but also highlight the importance of documenting them clearly in writing to ensure enforceability.

Characteristics of a Collateral Promise

A collateral promise functions as a side agreement that supports or guarantees the performance of another contract. Unlike an original promise, it does not establish a direct quid pro quo but instead provides assurance that another party’s obligation will be fulfilled. For example, a parent guaranteeing a child’s loan repayment is making a collateral promise.

Key features include:

  • Secondary obligation: The promisor’s duty arises only if the primary party fails to perform.
  • Conditional nature: Liability is triggered by another party’s default.
  • Requirement of writing: In most jurisdictions, such promises fall under the Statute of Frauds and must be in writing to be enforceable.
  • Third-party benefit: Often exists to assure creditors or counterparties rather than creating direct benefit to the promisor.

Michigan Statute of Fraud Law

As indicated by statute 566.132(1) of Michigan Compiled Laws (MCL), “an agreement, contract, or promise is void unless that agreement, contract, or promise, or a note or memorandum of the agreement, contract, or promise is in writing and signed with an authorized signature by the party to be charged.”

This means that a promissory note for a debt cannot be legally enforced unless it is signed. This Statute of Frauds defense is legally powerful but does carry some exceptions. Certain oral contracts can be enforced under the doctrine of promissory estoppel. However, this requires the plaintiff to prove that:

  • A promise exists.
  • The person who made the promise reasonably expected it would result in action on the part of the other party.
  • The promise created forbearance or reliance such that it must be enforced for justice to be served.

Promissory estoppel sometimes interacts and contradicts with the statute of frauds, so it's important to have a thorough understanding of both laws to avoid potentially expensive consequences. For example, let's say you want to grow your business and a friend of yours promises to pay all business expenses that exceed your expansion budget. However, he refuses to pay, creating substantial debt and resulting in failure of the company.

Because the promise was not made in writing, you attempt to sue under promissory estoppel and the defendant denies that a promise was made. The defendant argues that the promise falls under the statute of frauds and is thus unenforceable without a written agreement. This is where Michigan law distinguishes between collateral and original promises. An original promise is a promise to pay for services or goods that will be proffered at a later date. A collateral promise is a promise to pay for goods and services that have already been provided.

Based on this distinction, original promises are not covered by the statute of frauds and thus do not need to be made in writing. This is not the case for a collateral promise, which is how the business expenses in the above example would be categorized. Thus, you would lose the case without a signed promise, unless you can prove all required promissory estoppel elements.

Enforceability and Risks of Collateral Promises

While collateral promises serve an important protective function, they carry significant risks if not properly documented. If the agreement is oral, courts often deem it unenforceable under statutes of frauds. For enforcement, the promise must generally:

  1. Be in writing,
  2. Clearly identify the parties,
  3. Describe the underlying obligation, and
  4. Be signed by the party assuming the collateral obligation.

Risks include:

  • Ambiguity: Vague language can lead to disputes over whether a collateral promise exists.
  • Unintended liability: A party may be bound to obligations they did not anticipate.
  • Legal challenges: Courts strictly interpret these promises, especially in debt-related cases.

Businesses and individuals should seek legal advice before entering into collateral promises to ensure they are enforceable and aligned with their financial and legal interests.

Frequently Asked Questions

  1. What is the difference between a collateral promise and an original promise?
    An original promise creates a direct obligation to pay or perform, while a collateral promise supports another party’s obligation and usually requires a written agreement.
  2. Why must a collateral promise be in writing?
    Because it is secondary and tied to another’s obligation, most statutes of frauds require collateral promises to be in writing to prevent fraud and disputes.
  3. Can an oral collateral promise ever be enforced?
    Yes, in limited cases under the doctrine of promissory estoppel, if the promisee reasonably relied on the promise and injustice would result without enforcement.
  4. What are common examples of collateral promises?
    Loan guarantees, business lease guarantees, supplier payment assurances, and parental guarantees for student loans are common examples.
  5. What risks do collateral promises pose?
    They may expose the promisor to unexpected liability, create enforcement challenges, and be invalid if not properly documented in writing.

If you need help with a collateral promise, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.