Broadly, a personal guarantee is an obligation taken up by a person giving the guarantee that they will meet the obligations of another person or entity. This means that the person giving the guarantee known as ‘the Guarantor’, will be liable to fulfil the obligations of another person or entity if that entity fails to do so.
Personal guarantees are commonly seen in commercial contracts (for example a bank loan) where one party is a company and the director(s) of the company give a personal guarantee, guaranteeing the performance of the obligations by the company under the contract. Through this arrangement a creditor is able to ‘pierce the corporate veil’ and impose the obligations of the Company on to the directors who have given the guarantee. This is particularly helpful for creditors when dealing with new corporate customers with whom they have not had dealings before and may have doubts about the ability for the creditor to repay any debts that may fall due.
Given the implications of a personal guarantee it is important to seek legal advice before signing one.
It is important that at the time of signing a guarantee the guarantor should be aware of their obligations. A personal guarantee may be limited to a certain extent (for example in duration or for a certain amount). If the concerned party for whom the guarantee is given defaults on their obligations under the agreement, the other party can pursue the guarantor for any amounts owed to it by the concerned party to the extent of the guarantor’s obligations under the guarantee.
Some common features of a personal guarantee are as follows:
- the guarantor guarantees the other party the performance of the concerned party’s obligations under the contract;
- the guarantor may grant security over its real and personal property where there’s a ‘charging clause’;
- the guarantee may be continuing and unaffected by particular actions of the other party.
Generally, there are no time limits to a personal guarantee, even if there is a change of ownership in a company, a director’s guarantee may remain in place even if you are no longer a director in the company. For this reason, if you are selling your business and you have given guarantees over the years it’s very important to include in yours sales agreement a requirement for the new party to discharge (and where required replace) the guarantee.
From a creditor’s perspective it’s important to note that if the guarantor does not realise that they are giving a personal guarantee, this may lead to the guarantee being invalid. Further consideration also needs to be given where you have a guarantor that you know may be under a special disadvantage such as mental incapacity, illiteracy or lacks business acumen or if there is a material inequality in bargaining power between the parties. In this instance, it may be held that the guarantee is unconscionable and therefore invalid under the Contracts Review Act 1980 (NSW) or the Unfair Contract Terms provisions in the Competition and Consumer Act 2010. Therefore, it is important to ensure that if you do have a guarantee in your terms and conditions or contract, it is reviewed to ensure that one of the requirements is for the guarantor to have obtained independent legal advice.
What rights do you have against someone’s personal and real property under a personal guarantee?
Many guarantees contain “charging” clauses allowing the other party to take security over any real estate or personal property owned by the guarantor. This means that if the guarantor does not have enough cash to fulfil its obligations under the guarantee, the other party recover against the guarantor’s personal assets. For example, a valid charging clause would entitle the other party to lodge a caveat on any charged real estate owned by the guarantor.
Depending on where your interests lie as a creditor or as a guarantor, a personal guarantee is not to be taken lightly.
From a creditors perspective ensuring your personal guarantee is in fact enforceable is key. Particularly where you’ve providing ‘consumer credit’ you want to make sure that it is in compliance with all the sections of the Consumer Credit Code otherwise it may be unenforceable.
From a guarantor’s perspective, prior to entering any personal guarantee you want to always make sure you obtain independent legal advice to ensure you understand the level of risk you are accepting. Whilst you may not have the bargaining power to negotiate the terms with the creditor (for example a major financial institution) understanding what you are agreeing to is key to protecting your interests and knowing your risk exposure.
If you have a query relating to any of the information in this piece, or you would like to speak with a lawyer in Coleman Greig’s Commercial Advice team with regard to the purchase of a business, please don’t hesitate to get in touch today.
This material is provided by Coleman Greig Lawyers as general information only in summary form on legal topics current at the time of first publication. The contents do not constitute legal advice and should not be relied upon as such. Formal legal advice should be sought in particular matters.
