Personal Guarantees - What you need to know
Giving a personal guarantee is something that should never be done lightly. Sometimes you have no choice, for example if you are a director and shareholder of a company seeking funding. Other times you do – for instance; if your child is asking you to provide a personal guarantee to support their application for a home. In this situation you should know exactly what you are getting into and the risk to you and your personal assets.
What is a personal guarantee?
This is where an individual (“the Guarantor”) has agreed to ensure that a person or entity (“the Debtor”) will perform its contractual obligations to a third party (“the Guaranteed Party”) and if the Debtor does not perform its obligations, the Guarantor will step in and perform those obligations. A personal guarantee will usually contain a requirement for the Guarantor to indemnify the Guaranteed Party. This means compensating the Guaranteed Party for any costs (e.g. legal costs) and losses which it incurs as a result of the Guarantor not performing its obligations to the Guaranteed Party.
When is a personal guarantee required?
A Personal Guarantee is usually required when one party is incurring obligations to another party and that other party requires additional security for the performance of the other party’s obligations. This typically occurs where the Debtor has limited resources or limited experience. A common example is where a company enters into a supply contract under which the company is provided with credit. A company’s liability is limited to its assets. This means that if the company is unable to fulfil its obligations under the contract and the company goes into liquidation, an unsecured creditor will stand in line with all other unsecured creditors and there is a risk that it won’t get paid. In this situation the Supplier may require the directors and shareholders to provide personal guarantees so that it can make a claim of them personally.
Other common examples of where a personal guarantee is required include:
- A company entering into a lease as a tenant
- A company obtaining funding from a third party – e.g. a bank
- A company entering into a franchise agreement as a franchisee
- A sale and purchase agreement where the purchaser is a company
- Where a parent is asked to guarantee their child’s loan obligations to the bank when they purchase a home
What you need to know about personal guarantees?
- A personal guarantee is usually a principal obligation – this means that the Guarantor will be principally liable to the Guaranteed Party. The Guaranteed Party is therefore able to make a claim directly of the Guarantor (for instance; to pay money which the Debtor owes) without having made any claim against the Debtor.
- The Guaranteed Party may have no obligation to let the Guarantor know if the Debtor owes money to the Guaranteed Party or is breaching other obligations it owes to the Guaranteed Party.
- A Guarantor’s liability may be unlimited – meaning that that Guarantor will be personally liable for all amounts owed by the Debtor to the Guaranteed Party and this could increase over time (especially in the case of bank lending).
- If the guarantee document contains an indemnity, the Guarantor will not only be liable for all amounts owed to the Guaranteed Party but also for any costs (e.g. legal costs) and losses which the Guaranteed Party incurs as a result of any breach by the Debtor.
- The Guarantor’s liability may remain in place even when the Debtor has assigned the contract to another party. A common example of this is a lease. If the tenant sells the business and assigns the lease the party originally named as the Guarantor could remain liable until the end of the term.
- If you are unable to meet any claims made of you by the Guaranteed Party under the guarantee you could be forced to sell your personal assets and could potentially be declared bankrupt.
- If you are not the only Guarantor– you will be jointly and severally liable with the other Guarantors. This means that the Guaranteed Party can pursue you alone for the total amount owed and has no obligation to pursue the other Guarantors or make them pay a share of what is owed.
- The guarantee document may state that you agree not to obtain any security from the Debtor in return for you agreeing to be a Guarantor and you cannot make a claim of the Debtor in competition to the Guaranteed Party.
Tips for negotiating a personal guarantee
If you do agree to provide a personal guarantee, before you sign along the dotted line, our recommendations area:
- Get independent legal advice – you need to understand fully the implications of providing a personal guarantee. If you still want to proceed there may be some steps which can be taken to limit your liability.
- Do your due diligence - you need to make sure you have a good understanding of the financial viability of that person or company who is the Debtor. This is especially so if you are not connected with or have any control over the Debtor.
- Read the guarantee document – this may seem like strange advice, but it is not uncommon for us to come across clients who do not read what they sign. If there is anything you don’t understand – ask!
- Consider what effect a personal guarantee could have on your relationship with the person who is asking you to give a guarantee. Friendships or family relationships have the potential to be detrimentally affected or even destroyed – is it worth this risk?
- Are you happy with the risk of having your own personal assets exposed (and potentially lost) if a claim is made against you? It is worth considering your own asset protection strategy in this situation e.g. is your family home in your personal name or held in a trust?
- Negotiate for your personal guarantee to be limited by duration or amount or preferably both.
- If your personal guarantee is given in relation to a lease, insist that the guarantee document provides that your personal guarantee is released if the tenant assigns the business.
- If you are not the only guarantor – try to negotiate for any liability to be shared with the other Guarantors.
- Investigate what rights you have to information about the Debtor. Will you be informed if the Debtor is breaching its obligations? Are you able to request information from the Guaranteed Party?
- Understand how you can terminate your obligations under the guarantee and what the implications are if you do so.
If someone asks you to give a personal guarantee think very very carefully. A personal guarantee can be a serious financial commitment with far reaching implications. We can help you understand your obligations as a Guarantor and assist you to take steps to limit those obligations.
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