If you’re a business owner, director or parent, it’s likely that at one time or another you’ll be asked to provide a personal guarantee to contractually guarantee the performance of an obligation owed by a third party, whether it be to pay a debt, perform an act or duty. The third party (the principal debtor) is principally liable for the performance of its obligations to the creditor (whether a supplier of goods on credit, a bank, a landlord and / or financier).
The liability of the guarantor, being the person who gives the guarantee, arises upon the default of the principal in performing its obligations. The obligation of the guarantor exists only where an obligation on the principal has first arisen. In this sense, the guarantor’s obligation does not exist in a vacuum. Typically a guarantee comes to an end when the obligation to the creditor has been discharged by the principal debtor.
Cause for Concern
The mere fact that you’re being asked to personally guarantee another’s performance of an agreement says that the creditor has some doubts as to the principal debtor’s ability to perform and / or repay the amounts. In short, if the creditor is sufficiently worried enough to ask for a personal guarantee then you should be too. On this basis, personal guarantees should not be given away lightly. In fact, some would argue that they shouldn’t be given away at all.
Likewise, the fact that you may be considering a personal guarantee to secure an obligation suggests that there may be a level of uneasiness with the principal debtor’s ability to perform. The guarantor’s obligation is an accessory obligation insofar as it cannot exist without its principal obligation. Putting aside the many ways in which a guarantee may inadvertently be made ineffective (including from its drafting, execution, unfair contract terms to compromise), if there is an issue with the underling obligation in the principal agreement then this may in itself render the guarantee useless.
Co-Guarantors (Is there Safety in Numbers?)
Creditors regularly require multiple guarantors. One often overlooked risk is the failure of a guarantor to carry out due diligence on the financial standing of your co-guarantors. The focus is often on making enquiries and satisfying oneself on the ability of the principal debtor to perform – however, as the obligation to guarantee the performance of the principal debtor is often joint and several, your co-guarantor’s ability to chip in when needed becomes extremely important. What good is there having multiple guarantors if you are the only one able to help?
Each guarantor has a right against the other guarantor(s) to recover a proportion of any amounts that they may have paid out under a guarantee equivalent to the guarantees provided. However, the clear issues here are that often your co-guarantors are your business partners, co-directors or family members and to pursue your fellow guarantors would effectively be taking water from a well in which you both drink.
Last Guarantor Standing
If there is provision for multiple guarantors, make sure that you properly protect your interests when signing to ensure that if you are the only guarantor to have signed that, as at that time, you are not the only one to be bound and accountable.
Although there may be some basis to avoid being bound by a guarantee for the failure to have each of the intended co-guarantors execute (i.e. the creditor was obliged to have obtained additional guarantors and did not do so) often the signatories are bound irrespective of whether the other guarantors are bound by the guarantee. This depends on the specific terms of the guarantee. When entering a guarantee of this nature you must take steps to protect your interests in the interim until all intended guarantors have signed.
Not all Guarantees are Equal
Personal guarantees can vary widely. A personal guarantee may have one, some or none of the following features and therefore just because you may have provided or obtained a guarantee at one time or another it is important to read, fully understand and seek advice:
- Does it involve an indemnity for making good loss?
- Is the liability capped and does this exclude legal expense?
- Is the guarantee divisible (i.e. guarantees further obligations over the life of the guarantee) or an entire guarantee (i.e. guarantee of one supply or repayment of a single loan amount)?
- Does it bind your successors if you die or is it revoked by death?
- Does it provide for an equitable charge / right to caveat or mortgage property?
- Does it provide for the creditor to act as your attorney to effect and or enforce securities in discharge of the guarantee?
- Priority to enforce – does it provide for the creditor with the option to pursue the guarantor(s) (without having to pursue the principal debtor or enforce against any security);
- Joint & Several Liability – does it provide the creditor with the option to pursue any one or more guarantors.
The Wider Context:
It is also important to consider the wider context of the overall arrangement, for reasons including the following:
- Do you understand the obligation that you are guaranteeing the performance of?
- Does default bring forward the repayment of the entire debt (principal and interest) and not just require payment of the last overdue instalment?
- The possibility for cross-default of other loans and / or finance facilities of the guarantors;
- Ability to swap out personal guarantors without discharge of the principal debtor’s obligations, such as providing a personal guarantee as a director, and separate agreements to account for same;
- What is the financial position of the principal debtor and co-sureties?
- Value proposition. Who is the creditor? What is the risk? Is it worth it? Is there an alternative?
- Have you considered guarantor protection insurance and for your principal partner?
- Does the guarantee provide for security of obligations of principal debtors within the same group of companies?
Risk & Taking Stock
Often seeking or providing a personal guarantee, including just being asked or asking for one to be provided, is symptomatic of matters taking place around you that should prompt you to pause and take stock, consider your risk profile and, more particularly, your own circumstances and those of your business.
Consider the prospect of a personal guarantee as a useful opportunity to ensure that you have your affairs in order and, in particular, to ask yourself what provision do you have in place to protect your interests if things go wrong?
If you’re extending credit, whether by a loan, supplying goods or services or leasing a property you may wish to offset the risk by seeking a personal guarantee of those obligations to be made to you. It is imperative that in doing so that the personal guarantee is valid and effective. An effective personal guarantee is the high water mark for debt recovery; however, on the flip side a simple oversight can also render it ineffective, including inadvertently having compromised the debt such as by having varied the terms of the agreement with the principal or having received some amounts in satisfaction of a debt outstanding.
Contact MBA Lawyers if you’re considering a personal guarantee to secure an obligation or you have been asked to provide a personal guarantee as it is important to properly understand your rights, obligations and consequences.
Authored by Senior Associate, Rhys Donnelly.