Personal guarantees are a standard business practice in commercial transactions, however, they are often misunderstood and can pose significant financial risks.
A personal guarantee is an agreement of one party to answer for the debt, default or miscarriage of another.
Director guarantees are a common type of guarantee, where the director of a company receives a request for a personal guarantee which holds them liable for the company’s debt if the company does not meet their obligation, i.e. fails to pay.
These guarantees are usually required in loan, lease or other finance arrangements with small companies. Personal guarantees can be given in the form of a deed or a contract. When given in the form of a deed, it must be in writing and conform with a number of statutory requirements to be enforceable.
Here are five things to consider before signing a personal guarantee:
The extent of the guarantee
Review the total amount that must be repaid under the guarantee and be wary of any other costs that may be added to the debt. For example, the wording of the guarantee may include other amounts which may be claimed under the guarantee, such as mercantile fees, legal costs and interest. These additional costs can significantly exceed the original amount when the final amount is owed.
How the guarantee will be released
The release of the guarantee will vary depending on the type of agreement. In some circumstances, the guarantee will not be released until an amount has been repaid in full or there is an expiry of a lease. On other occasions, the guarantor may be able to negotiate for an earlier release.
Company directors should be aware that ceasing a relationship with the company, i.e. resigning from their role, does not automatically terminate a guarantee. The guarantor must obtain the consent of the creditor/lender, and potentially the debtor person/company, to be released from the guarantee.
What happens if there is more than one guarantor
In cases where there is more than one guarantor, joint or several liability for the debt may be accepted. This type of liability may hold both or even just one guarantor equally liable for the debt. The terms of the agreement may hold one guarantor responsible for all the debt if the other guarantor does not meet their obligations. In addition, creditors may be able to selectively enforce the debt on one guarantor.
Understand the terms and wording of the guarantee
Consider the consequences of the terms you are accepting and remember each guarantee is different. The wording of the guarantee will also dictate whether it is secured or unsecured, and what debts may be claimed. For example, an ‘all moneys’ guarantee means that you will be liable for all the debts and obligations of the company.
Be aware of the legal and financial consequences
Make sure you understand who you are providing the personal guarantee on behalf of and the likelihood of the person/company not being able to pay the debt. Read the contract carefully and obtain independent advice before signing to understand the limit, extent and impact of the guarantee.