Securing performance of obligations: what to choose in a contract

Most often, people come with a question about securing performance of obligations after the counterparty has already breached deadlines or stopped responding, and the contract has no clause that would allow them to get what is owed quickly. The opposite also happens: a transaction is only being prepared, and you need to understand in advance which mechanism will suit — a penalty, pledge, suretyship or something else. Security is formalised before the main contract is signed or at the same time as it, and the chosen structure determines how realistic it is to recover the debt or secure performance.

The article examines the methods of securing performance of obligations named in the Civil Code of the Republic of Kazakhstan and the logic of choosing between them. It separately considers contract terms, sector-specific nuances for loans, lease and construction contracts, as well as situations in which security does not work. The material is aimed at a reader in Almaty who is encountering this for the first time — without unnecessary theory and with practical guidance.

What securing performance of obligations is and when people think about it

Securing performance of obligations means additional legal mechanisms that increase the creditor's chance of actually obtaining performance. The main obligation answers the question of what and when the debtor must do: repay a loan, pay rent, deliver goods, perform work. Security answers a different question: what will happen if the main debt is not performed or is performed improperly.

Why securing performance of obligations is needed: it narrows the room for bad-faith behaviour and gives the creditor leverage without letting the situation drag into a lengthy dispute. Security is also useful for the debtor — it shows seriousness of intent and allows them to obtain a deferral, instalment plan or softer terms.

• a penalty — a sum of money for delay or improper performance
• pledge — property out of which the creditor obtains satisfaction
• retention — the creditor retains the debtor's item until the obligation is performed
• suretyship — a third party is liable to the creditor together with the debtor
• guarantee — the guarantor is liable to the creditor for the debtor's non-performance of the obligation
• deposit — a payment confirming the conclusion of the contract and securing its performance

Types of securing performance of obligations: a brief overview and the logic of choice

The Civil Code of the Republic of Kazakhstan names the following means of securing obligations: penalty, pledge, retention of the debtor's property, suretyship, guarantee, deposit and others provided for by law or contract. The list is open: the parties may also agree on an unnamed arrangement, for example a security payment. The choice depends on what matters more — swift compulsion to perform, retaining control over an item, or bringing a third party to liability for the debt. That is why types of securing performance of obligations are selected for a specific transaction, not by template.

All means fall into personal and proprietary. Personal security adds another obligated subject alongside the debtor: the surety and the guarantor are liable with their own property alongside the principal debtor. Proprietary security ties the creditor to a specific asset — pledge, retention; on non-performance the creditor obtains priority over other creditors in respect of that item. Penalty, deposit and security payment occupy an intermediate position: they are monetary incentives that work without separate property.

• Penalty — a sum of money for delay or other breach; suitable for transactions with regular payments and supplies.
• Pledge — the creditor obtains priority over the pledged item; appropriate for lending and instalments secured by a valuable asset.
• Retention — a creditor in possession of the debtor's item may refuse to return it until performance; convenient in construction, carriage and storage.
• Suretyship — a third party is liable together with the debtor; used where the principal debtor has insufficient property.
• Guarantee — the guarantor's obligation to pay the creditor upon breach of terms; in demand in banking and large commercial transactions.
• Deposit and security payment — sums of money that encourage performance; the deposit is intended to confirm the conclusion of the contract, the security payment to cover possible losses.

The methods can be combined: for example, a penalty together with a pledge or suretyship strengthens the creditor's position in securing the performance of obligations in Kazakhstan.

Penalty as security for the performance of obligations: when it works

A penalty appears in contracts more often than other methods of security. It works simply: the debtor breaches a term — and must pay on top of the principal debt. That is why a penalty is included in almost every supply, contract work or lease agreement.

A distinction is drawn between a statutory and a contractual penalty. The statutory one applies regardless of whether the parties have set it out — it is enough that it is established by a rule of law. The contractual one applies only where the parties have expressly agreed it in the text, specifying the calculation procedure and the ground. If there is no such term, a contractual penalty cannot be recovered.

• A statutory penalty applies by force of a rule of law, regardless of a term in the contract.
• A contractual penalty works only where expressly agreed by the parties.
• Penalty interest is charged for the period of delay, while a fine is charged once for the breach.
• The amount of the penalty should be proportionate to the consequences of the breach.
• A clearly inflated amount gives the debtor grounds to ask for a reduction of the penalty.
• The court may reduce the penalty if it finds it disproportionate.

Pledge and retention: proprietary security for the performance of obligations

Proprietary methods tie a specific thing or right to the obligation, and on non-performance the creditor gains priority over other claimants. Both movable and immovable property, as well as property rights, may be the subject of a pledge.

Security by pledge arises from a contract and, in cases expressly provided by law, from the law itself. The contract includes the subject with a description allowing it to be identified, its valuation, the substance and amount of the secured obligation, the time for its performance, who retains the pledged thing, the creditor's right to check its condition, and the procedure for enforcement.

• the subject of the pledge with a description allowing the thing or right to be individualised
• the substance, amount and time for performance of the secured obligation
• who retains the subject and how the creditor checks its condition
• the procedure for enforcement and sale of the subject
• information on prior pledges and encumbrances
• the terms for storage and return of the retained thing

Suretyship and guarantee in the system of securing the performance of obligations

Suretyship is built on a third party: the surety is liable to the creditor for the debtor. The basis is a suretyship contract between the creditor and the surety in written form. Under the Civil Code of the Republic of Kazakhstan, the surety as a general rule is liable jointly and severally with the debtor, unless the contract or legislation provides for subsidiary liability.

A guarantee under the Civil Code of the Republic of Kazakhstan is close to suretyship: the guarantor is liable to the creditor for the debtor's non-performance, as a general rule subsidiarily, unless the contract provides for joint and several liability. Separately, the legislation of the Republic of Kazakhstan regulates a bank guarantee. A security payment is closer to a deposit and an advance: the sum is paid in advance, is set off against performance or is returned; its coercive function is weaker.

Security rarely saves the day after the fact: its value lies in having been agreed and formalised before the counterparty breached the obligation.

What to compare when choosing security for the performance of obligations: a clear table

Choosing security for the performance of obligations starts with understanding what exactly protects the creditor. Some measures create a monetary claim, others give access to specific property.

A separate transaction is not always needed: a penalty and a deposit often live in the main contract, while a pledge and suretyship require separate formalisation. Specific property serves as security in the case of a pledge and retention; a penalty, deposit and suretyship do not provide such security. The difficulty of enforcement depends on whether enforcement must be directed at a specific thing or whether it is enough to bring a claim.

• who is liable: the debtor, a third party or specific property;
• whether a separate transaction and its registration are needed;
• whether the obligated person has liquid property;
• how simple and quick enforcement is;
• whether the protection depends on the preservation of the subject;
• whether several methods can be combined in one contract.

The methods can be combined; the choice depends on the subject matter of the transaction and the risk.

Securing performance of obligations in a contract: wording and risks

The provision on security is set out in the contract or in a separate annex document. The wording must name the method, the amount, the procedure for applying it and the moment it takes effect. If the method is named but the mechanism is not disclosed, the clause works only formally and does not protect the creditor in the event of breach.

A separate agreement must be linked to the main contract: the parties, the subject matter, the obligation secured. Without this, there is a dispute over which obligation is secured and to what extent.

If the provision is absent or incomplete, the creditor loses additional instruments and has to prove the breach in the general manner. The gap cannot be filled in retroactively: correspondence does not replace an agreed clause, and it must be corrected before signing.

• State the method of security directly in the text of the contract or in an annex to it.
• Link the security agreement to a specific principal obligation with its details.
• Disclose the mechanism: out of what, in what order and when the creditor obtains satisfaction.
• Check whether the security clause contradicts the terms of the main contract.
• Record the consequences of invalidity or termination of the principal obligation for the security.

Securing performance of obligations in a loan, lease and works contract: sector-specific nuances

The choice of security method depends on what needs to be protected: repayment of money, preservation of property or the quality of works. In a loan, the creditor's interest is focused on repayment of the amount, so the security is built around pledge and guarantee: a pledge gives priority over a specific item, while a guarantee adds a second obligated person alongside the debtor. If the subject matter of the loan is money for a future supply, it is useful to link the security structure in advance to the security for supply obligations, so that if shipment fails there is no need to look for new arrangements.

In a lease, the main risk is not so much non-payment as the condition of the object and timely vacating. Security for lease obligations usually rests on a security payment and a penalty: the payment covers the debt and damage to the property, while the penalty keeps the deadlines in check. It is important to describe the security payment so that it is clear what it is withheld for and in what order the remainder is returned. Pledge and guarantee are used less often: they are appropriate where the lease is long-term and the object requires investment.

When security for performance of obligations does not work: typical mistakes

A security method does not protect the creditor if it is executed with violations. Most often security fails to work because of legal errors at the time of conclusion.

A common scenario is a surety for a person with no property: without assets, the arrangement does not cover the debt. Next is an unregistered pledge: there is no agreement in the required form, no registration where it is mandatory, or no pledged item in kind. Risks grow when no check is made of what the surety or pledgor is liable with.

• Check whether the surety has real property and income that enforcement can be directed against.
• Make sure the pledge agreement is concluded in writing, contains an exact description of the item and is registered where this is required.
• Check the surety and pledge periods against the date of performance of the main obligation and the moment the claim is made.
• Compare the terms of the main agreement and the security transaction: a change in the amount, term or obligation without the surety's consent deprives the protection of its meaning.
• Check the wording on the scope of liability and the grounds: they must be defined unambiguously.
• Keep evidence of the transfer of the pledged item, the deposit and the arrangements reached — without them, challenge or enforcement becomes difficult.

Termination and amendment of security for the performance of obligations

Security follows the fate of the main debt. Where the main obligation is duly performed, the security terminates automatically, without a separate agreement.

Security may be amended by agreement of the parties in the same form as the original transaction. If the main obligation is amended without the surety's consent in a way that increases its liability (for example, the debt amount grows), the surety under the Civil Code of the Republic of Kazakhstan terminates. A third-party pledgor must also agree to amendments in advance.

• performance of the main obligation in full;
• expiry of the surety period without a claim being filed;
• loss of the pledged item or termination of the pledged right;
• amendment of the main obligation without the consent of the surety or pledgor;
• agreement of the parties to replace one security method with another;
• transfer of the debt to another person without the consent of the surety or pledgor.

Security for the performance of obligations: steps for a reader from Almaty

Security for the performance of obligations begins with an assessment of risk: the likelihood of non-performance and the loss. This determines the choice of method. For monetary claims, a pledge or surety is more often taken; for non-monetary ones, a penalty and a deposit are sufficient.

Checking the counterparty precedes execution: information on registration, the composition of participants and encumbrances on property is available through open sources. Execution is done before a notary or in simple written form, unless the law requires otherwise. The pledge agreement must allow the item and the substance of the secured obligation to be determined unambiguously.

• Determine which obligation is being secured and what the size of the risk is.
• Choose the method: penalty, pledge, retention, surety, guarantee, deposit.
• Check the counterparty and its property through open sources.
• Draft the security agreement and the main agreement without contradictions.
• Have the documents certified by a notary where the law requires this.
• Register a real estate pledge in the Legal Cadastre through a Public Service Centre or eGov; a pledge of movable property — in the register of pledges of movable property, if registration is mandatory for it.