Guarantees are given only when some direct ad vantage in interest rate or price is to be obtained, and this requires that the guarantor corporation be of the first rank. The guarantee is only considered as a contingent liability of the guarantor. Very often it occurs that prior bond issues limit the further bor rowing power of a corporation, so that the only way it can utilize its credit for new funds is to guarantee the obligations of the subsidiary companies, or buy on lease. Ordinarily, a large company that is free to borrow will prefer instead to put out its own obli gations, secured by the deposit of the stocks and bonds of its subsidiaries, in the form of collateral trust bonds.
The fact that the contingent liability of an indorse ment is often difficult and expensive to enforce, the legal remedy of the holder consisting in a suit against the indorser or guarantor, is a strong objection to this type of security. It is also apparent that the un limited use of the guarantee May jeopardize the sol vency of the indorser or guarantor, especially when the income of the guarantor depends largely upon the receipt of dividends or interest from the sub sidiaries whose obligations are guaranteed. This lat ter practice merely pyramids credit without affording any real additional protection, and constitutes an un sound financial expedient. The value of an indorse ment or guarantee may, of course, be protected to some extent by limiting the contingent liability of the indorser, or guarantor, say to a certain percentage of its capital and surplus.
3. Forms of guarantee.—Corporate guarantees may be strong or weak, according to their wording. The indorsement or guarantee of a corporate bond has the same significance as the guarantee upon a prom issory note, the guarantor merely assuming the con tingent liability of paying the obligation if the debtor fails to do so. If the guarantee goes further than this, the guarantor may become a direct obligor, pro tected only by his right to recover from the borrower whose obligation he guaranteed. This might be called an "assumed bond," the clause reading about as fol lows: The Blank Company, of New York, for value received, hereby assumes and agrees to pay the principal and interest of the within bonds as the same shall respectively become payable.
The weak guarantee, on the other hand, contem plates no action on the part of the guarantor, except to insure the bondholder against ultimate loss in the event the obligor defaults. The following form is
typical: The Blank Company, for value received, hereby guaran tees to the holder of this bond the prompt and punctual pay ment, according to the terms thereof, of the principal and interest, and further guarantees to the said holders that the sinking fund instalment provided in the mortgage and deed of trust and in said bond referred to shall be made in the manner and to the extent therein provided.
In this weak form, the guarantor does not himself assume the obligation. In the strong guarantee, however, the guarantor agrees to make payment at once if there is a default. Following is a typical form of strong guarantee: The Blank Company, for value received, hereby uncon ditionally guarantees to the owner of this bond the payment of the principal and interest thereon, as the same matures and falls due, and hereby agrees himself to immediately pay the said principal and interest if any default occurs in the payment thereof.
4. Features common to the deed of trust.—All forms of corporate bonds or notes, issued in series and sold to the public, other than plain debenture obliga tions, require the deposit of collateral with a trustee for the equal protection of those who hold the bonds or notes. It is the transfer to the trustee of this property, or instruments evidencing property rights, together with the usual declaration of trust, which gives to the indenture its name "Deed of Trust." The form of the property pledged determines the special provisions which must be inserted in the trust deed to protect the interests of the corporation and the bondholders, and to outline the duties of the trustee. Certain features, however, are common to practically all deeds of trust, whether the security de posited with the trustee is in the form of a mortgage upon real estate, stocks and bonds of other compa nies, or a lease. If the security is real estate, the deed becomes a mortgage, as we have already described in detail in the preceding chapter. If stocks, bonds or leases are deposited, the granting clause merely vests these in a trustee as a pledge of collateral, and the obligations are known as collateral trust bonds.