What is a Personal Guarantee?
A personal guarantee is a promise by an individual (the guarantor) to fulfil the obligations of a party (usually a company), should that party fail to meet a payment obligation under an agreement. Fundamentally, by entering into a guarantee, the guarantor will become personally liable instead of or in addition to the party for a breach of the party’s obligations.
A common example is a company director giving a personal guarantee when a company is pursuing a line of credit. Usually, more than one director would provide a personal guarantee to the lender so the lender is satisfied that in the event the borrower fails to pay, the guarantors themselves will be “on the hook”.
If in the event more than one director provides a personal guarantee, it will more likely than not be on a joint and severable basis. In simple terms, the lender does not need to treat the guarantors equally or fairly, so if a demand is served under the guarantee the lender could pick one of the guarantors if they felt they were an easier task than the other. Usually, the “one with deeper pockets” will be the lender’s first option to recover the unpaid debt.
When are Personal Guarantees usually given?
There are a wide array of situations where a personal guarantee may be required. Common examples include:
- Any sort of loan agreement where security is being given by a borrower in consideration of the loan;
- Invoice payment agreements; and
- Property leases.
What are the risks?
Should the borrower fail to adhere to the agreement, the guarantor’s personal assets are immediately at risk. Meaning, the lender can issue court proceedings under the terms of the personal guarantee against the guarantor. Any Judgment granted can be enforced against the guarantor’s personal assets, including their property and any personal savings accounts.
Further, if the guarantor leaves the company whose liabilities they have guaranteed or indemnified, it is not safe to assume that their liability has ended as well. The agreement will not be automatically unfair if there is no specified timeframe in which the agreement binds the guarantor.
Due to the significant risks involved, it is crucial that the potential guarantor seeks independent legal advice in relation to the proposed personal guarantee agreement.
On the other hand, when acting for a lender or other party requiring a personal guarantee, it’s similarly crucial that the guarantors get independent legal advice. This minimises risk of a situation further down the line where the guarantor attempts to claim they did not fully understand the content and effect of the personal guarantee they entered into. This could result in the guarantee being declared void, removing a layer of security.
How are guarantees treated?
The law surrounding personal guarantees and indemnities is considered to be “lender friendly”. For example, the Court’s default position is that the guarantor has entered into the agreement knowing what they are signing up to. Again, this stresses the importance of a potential guarantor seeking independent legal advice at the earliest opportunity to understand the nature of the agreement they are entering into. If the guarantor is to sign the guarantee and indemnity, it is no defence to later claim they did not understand the nature of the agreement, or its terms.
However, this is not to say that it is impossible for the guarantor to absolve themselves from some or all liability. There is usually scope for a sensible negotiation with the lender, prior to them enforcing the agreement. Further, the guarantor could rely on several technical legal points to reduce or exclude liability, some examples include misrepresentation, undue influence and timing of signing the documentation.
It is clear from the above, that the advice for any potential guarantor is to seek independent legal advice at the earliest opportunity, to ensure they are fully aware of the nature and risks of the agreement they are looking to sign. It is also crucial that the guarantor seeks advice in any event whereby there is a potential for the lender to enforce the agreement against them personally.