Personal guarantees are common in business transactions. It is a written promise to guarantee the liability of one party for the debts of another party.
Typical scenarios where personal guarantees will be required include:
- when a supplier gives credit to a business carried on by a company;
- when a landlord leases commercial premises to a tenant that is a company;
- when a company borrows funds from a financial institution.
The three parties to a guarantee are:
- Party A and Party B – the two parties to the agreement; and
- The Guarantor(s) – the person giving the guarantee who promises to Party B that it will fulfill Party A’s obligations under the agreement if Party A does not fulfill them.
Commonly, personal guarantees are given by directors of the company to personally guarantee the payment of money or obligations on behalf of the company. It is additional security for Party B in the event that Party A fails to comply with its obligations under the terms of the agreement.
The terms of the guarantee will determine the Guarantor’s liability. It is recommended that you read and understand the effect of the personal guarantee, and if in doubt, seek legal advice regarding your obligations.
A few things to look out for before signing a personal guarantee:
Understand what you are promising to do
Ensure that you understand what it is you are promising to do. If you are guaranteeing all of the obligations of Party A pursuant to the agreement, you will need to know what those obligations are (by requesting a copy of the agreement between Party A and Party B) and Party A’s capacity to fulfil those obligations.
For example, if Party A defaults on its obligations under the agreement, Party B can pursue the Guarantor personally for any amounts owed to it by Party A to the extent of the Guarantor’s obligations under the guarantee. Party B may seek judgment in court against the Guarantor pursuant to the guarantee if the Guarantor does not comply with its demand for payment. If Party B obtains judgment against the Guarantor, it will be entitled to enforce that judgment in the usual ways, which may include making the Guarantor bankrupt.
Many guarantees effectively put the Guarantor in the place of Party A under the agreement. Party B may call on the Guarantor instead of Party A when Party A is in default.
Many guarantees also contain “charging” clauses which allow Party B to take a charge over any real estate owned by the Guarantor. By giving a charge over real estate, the Guarantor is giving an interest in the land it owns to Party B as security for the monies owed by Party A under the agreement. A valid charging clause will entitle Party B to lodge a caveat on any charged real estate owned by the Guarantor.
Duration and cancelation of the personal guarantee
Personal guarantees are generally continuing guarantees and have no time limit. The Guarantor is guaranteeing the obligations of Party A and the Guarantor can be held liable for any present and future obligations of Party A pursuant to the agreement, typically until Party A’s obligations come to an end.
Ceasing to act as a director of Party A does not, of itself, terminate a guarantee. The Guarantor will need to negotiate with Party B to have the guarantee terminated.
Personal guarantees are not without risk. Caution should be taken when entering into a personal guarantee, if at all. Practically, however, personal guarantees will likely be insisted upon by Party B if Party A would like to carry on business, borrow funds or lease commercial premises.
What then is good legal advice in these situations?
Potential guarantors should consider:
- undertaking an assessment of the financial viability of the business before signing the guarantee, particularly if the business/credit is high risk and the financial benefit is uncertain;
- capping the liability under the guarantee at a dollar amount;
- negotiating the removal of a charging clause from the guarantee;
- including an expiry date to the liability under the guarantee;
- negotiating an interest rate charged to the guarantor under the guarantee to a commercially realistic rate;
- seeking a release from the guarantee if no longer involved in the business.
Before entering into a personal guarantee, seek legal advice. At Cohen Legal, we can provide comprehensive advice so that you fully understand your obligations under any proposed personal guarantee. Talk to us today.