A standard business practice of many corporations – particularly direct suppliers of goods and services, and banking institutions – is the requirement that a credit account be accompanied by personal guarantee. This is unsurprising, given current corporate insolvency rates, and the inherent risk that if a corporate debtor goes into liquidation, the supplier may receive only a few cents in the dollar on their debt – if that.
What is a Personal Guarantee?
A personal guarantee is an agreement or promise by one party to be liable for the debts of another. A common type of personal guarantee is a Director’s guarantee, where the Director can be pursued in their personal capacity for the debts of the company owed to the party the guarantee is given to which are not paid within terms.
Personal guarantees can be unsecured (a general guarantee, not attached to a particular asset) or secured (where it specifically includes the granting of security over land or another asset). The wording of the guarantee may also include other amounts which may be claimed under the guarantee, such as mercantile fees, legal costs, interest, and the like.
The wording of the guarantee will dictate whether it is secured or unsecured, and what debts may be claimed. If you have any doubt about whether you are granting a security, or the extent of the guarantee, obtain legal advice before signing.
Risks of Signing a Personal Guarantee
Be aware that even if the guarantee does not provide a security over assets, if a demand is made under the guarantee and the debt is not paid, the creditor is able to seek judgment at Court for the sum claimed (in the guarantee) against the guarantor personally. If judgment is obtained, the creditor will be entitled to use standard enforcement methods – such as warrant of seizure and sale, or (depending on the situation) a warrant on title, to sell real property, or if the amount remains outstanding, issuing bankruptcy proceedings.
It is important to be cautious when signing a personal guarantee, given the far reaching consequences which may occur.
Be aware also that ceasing to have a relationship with the company does not automatically terminate a guarantee – even if it was a personal guarantee signed as a Director, and the guarantor has resigned from that role, or the company has gone into external administration (such as liquidation).
To be released from a personal guarantee, the guarantor must obtain the consent of the creditor/lender, and potentially also the debtor person/company, depending on the agreement and surrounding obligations.
Factors to consider before signing a guarantee
It is advisable to consult your lawyer so that your rights and liabilities can be properly explained to you. Each guarantee is different and turns on the clauses set out in the agreement. Therefore it is imperative that you understand the legal consequences of signing on as a guarantor.
If you are a creditor who requires a personal guarantee be given, you should ensure that you give the guarantor the opportunity to seek independent legal advice, so that you can be satisfied that there was informed consent at the time the guarantor signed the guarantee.
Can a personal guarantee be set aside?
There are instances when a personal guarantee may be set aside, however this is not straightforward.
A guarantee might be set aside if it has been obtained in unconscionable circumstances (such as where someone has not benefited from the transaction, but has provided a guarantee without the risks and obligations being made clear) such that the guarantee cannot be considered to have been entered into independently or voluntarily by the guarantor. Similarly, it could be set aside where it is shown that the innocent party was unable to make a worthwhile judgment as to what is in their its best interest.
Another issue which may cause a personal guarantee to be set aside is where there has been undue influence or pressure, compelling a guarantor who does not understand the nature and effect of a guarantee to provide the guarantee. This may be due to emotional dependence, such as where a person has been induced to sign the guarantee by their spouse, in the context of emotional dependence and where there is a relationship of trust and confidence. Language ability can play a role here.
How to protect your interests
- Whether you are receiving personal guarantees from debtors, or signing them for a creditor, always keep a copy of guarantees which relate to your interests and liabilities.
- Obtain legal advice regarding any guarantee you or your company may wish to rely on – be sure that it protects you as well as possible, and that you understand how you can use it – and request that any guarantor obtain independent advice before signing.
- Obtain legal advice regarding any guarantee you wish to sign so that you understand what it means, how far it reaches, and what its impact may be.
Personal guarantees can be powerful when drafted well, and used correctly. If you would like to talk to a lawyer about ensuring your personal guarantee is as enforceable as it can be, or if you would like some advice on what a personal guarantee means for you as a guarantor, please contact Peter North (Director of Business) on (03) 9629 9629.