Personal guarantees have become a common part of many commercial transactions, often being provided by company directors and their spouses or relatives.
However, in our experience, the extent of such guarantees are often misunderstood and can create unexpected consequences when businesses experience financial difficulty. In extreme circumstances, they can be the cause of relationship breakdowns as guarantees are enforced against those closest to us.
A personal guarantee is, in essence, one party agreeing to cover or answer for the debt or obligations of another. Whilst most commonly sought from directors, they can often be provided by spouses or parents of those incurring the debt or obligation. They usually appear in loan or finance documents but are often also incorporated into property or equipment leases, hire agreements, supply agreements etc.
Whilst the law in relation to guarantees is evolving to account for electronic signatures and agreements by exchange of electronic contracts, they generally still need to conform with some strict statutory and common law requirements in order to be enforceable. A number of key questions should be considered before giving a personal guarantee. The following are a few key areas which should be considered when providing a guarantee
What does it cover?
Make sure you are clear as to what the guarantee covers and its scope. What is the total amount that must be repaid under the guarantee? Does the guarantee cover the principal/ interest/ costs of recovery and legal costs? Is the guarantor being asked to meet just this debt or are they agreeing to cover all debts to the creditor? Does the guarantee allow a charge over the guarantor’s real property (land)? Does it require that the guarantor consent to a caveat over their property?
Unfortunately, guarantors often only truly understand the extent and scope of the guarantee when the creditor is seeking to enforce it.
In circumstances of joint guarantors, each guarantor will often be jointly and severally liable for the debt and the creditor will be at liberty to choose who they pursue to recover the debt. This is particularly dangerous in circumstances where the spouse of a director is the holder of the main assets such as the family home and will often be the creditors first choice.
How will the guarantee be released?
You should make sure you are aware of what needs to be repaid or completed in order to be released from the guarantee. Is it released on repayment in full? The expiry of the term of a lease? Return of rented goods? A final inspection of property to ascertain its condition?
Guarantors should ensure that the terms of any guarantee make clear the circumstances in which their liability ceases. Company directors should also be wary when negotiating their exit from a company to ensure that all guarantees they provided during their tenure are properly released as part of their exit.
Are there alternatives to a personal guarantee, and if not, can the guarantee be limited?
Often, personal guarantees are given in circumstances where they can be avoided. Does the business have other collateral it can offer as security for the contractual obligations? For example, can it afford to pay a bond on a lease, offer some other asset as security or seek a bank guarantee for its obligations?
Remember that guarantees, like any other term in a contract, can be negotiated. In circumstances where they are absolutely necessary, they should be confined and limited so as to avoid nasty surprises is they are enforced.
If you are concerned about a particular guarantee being sought or would like to know more about your rights pursuant to a guarantee you have given, please contact our team for on-point advice.
Joseph Carneli, Rankin Business Lawyers