The importance of legal advice when providing a guarantee.
By Youssef Abouelnasr and Nicholas Kyriakoudes
Personal guarantees are legal agreements which entail a third party (the guarantor) promising to ensure that a particular legal duty owed to another party (the beneficiary) by some other entity (whether that be a person or company) will be performed and (if not performed then) agreeing to be liable in the event of a breach (the guarantee). In commercial and retail leasing, where the tenant is a company, it is common that the landlord will require the directors and/or shareholders of the tenant company to provide personal guarantees. Another time you may be asked to provide a personal guarantee is where you agree to be guarantor for your children’s home loans. Essentially in these contexts, a personal guarantee is a commitment to guarantee the repayment of the debt to the beneficiary (e.g., a lender or landlord).
What does a personal guarantee entail?
Personal guarantees provide the Beneficiary with security for the repayment of the debt or obligation. This is because generally each personal guarantee will provide that you, as the guarantor, are personally liable to the Beneficiary for the amount or thing that you are guaranteeing. For example, in the repayment of a loan, the amount or balance of the loan.
Guarantees are required where the person or entity entering an agreement is separate to the person providing a guarantee. For example, a company being a lessee is an obligation which binds only the company and not is directors or shareholders. By requiring a director or some other person to sign a guarantee, the other party (in the above example, the lessor) can have assurance and a back up if the company fails to comply with its legal obligations. For example, if a guarantee is not signed and the company defaults on rent, the lessor would be limited to suing only the company for that debt. That might not be commercially viable for a number of reasons including if the company is insolvent. By executing a guarantee the lessor’s interest is protected as it can enforce its rights to payment of the rent not only against the company but against any person or entity whom has guaranteed the lessee’s performance of their contractual duties. For example, the lessor can sue the directors personally who provided a guarantee that the lessee company would comply with the terms of the lease.
Take another another example of your children applying for a home loan and requesting you personally guarantee the loan. Generally, guarantee provisions would provide that you are personally liable for everything that your children were liable for under their home loan. What is not as obviously advertised is that these guarantees also often provide that in the case your children are failing in their obligations to repay the home loan, the lender does not have to legally pursue them before they pursue you under the guarantee provision you have signed.
Another popular provision of guarantee provisions provided by lenders is the ability to set-off. What this means is that if you hold an account with the financial institution that your children are borrowing from, this financial institution can take money out of your account without your permission to meet the failed obligations of your children.
Risk
Whilst guarantees minimizes risk for the Lender or Landlord it is important to be conscious of the risks that guarantees creates for you as a guarantor. By giving a personal guarantee you are exposing your personal assets if you do not honor the guarantee when the Beneficiary requests it from you. It is also important to ensure that any personal guarantee you provide does not allow the Beneficiary to vary the obligations without your consent, for example increase the amount your children borrow and hence increase the amount you may have to repay. When providing guarantees it is also prudent to consider the trustworthiness and reliability of the entity or person whom you are providing a guarantee for. For example, you may feel more comfortable providing a guarantee for a company which you are the sole director and shareholder of as you can control the company’s activities rather than providing a guarantee for a child for their loan where that child is somewhat irresponsible with their funds. This is one of many commercial considerations that you should take into account before executing a guarantee.
The multitude of pitfalls and issues that need to be considered when agreeing to provide a personal guarantee highlights the importance of having such guarantees reviewed by professionals. Hansons Lawyers has decades of experience in advising on guarantee provisions. We invite you to contact us to discuss your situation with our experienced Property & Commercial Law Team.
Feel free to contact us on 42 222 666 or by email at hansons@hansonslawyers.com.au