A personal guarantee is a promise made by a person (known as a guarantor), that they will personally meet the obligations of another person or company if that person or company defaults on their obligations under an agreement. Personal guarantees are a mechanism which lifts the corporate veil, allowing for creditors to enforce a debt or obligation on a director of a company personally. Without a personal guarantee, a company director is not personally liable for a company’s debts. If you are a person providing a personal guarantee for a company, there are risks you should be aware of, and on the contrary, if you are a business entering agreements with the potential for loss or non-payment, there can be great benefit and risk minimisation to require personal guarantees from individuals behind your corporate customers.
Circumstances personal guarantees may be requested
Directors of a company may be requested to provide a personal guarantee if the company of which they are a director is entering a:
- Lease agreement;
- Loan agreement or other financing arrangement;
- Trade and supply agreement;
- Sales contracts for land, business, shares or any other property; or
- Building and construction contracts.
Risks to consider when providing a personal guarantee
If entering an agreement on behalf of a company, company directors may be asked to give a personal guarantee. This means, the person providing the guarantee (the guarantor) becomes personally liable for the debts and obligations of the company under the agreement if the company defaults.
A personal guarantee is a binding contract that becomes legally enforceable the moment all parties execute it. If a director of a company has been asked to provide a personal guarantee, key factors to be considered include:
- Bankruptcy – If it becomes necessary for a director to personally cover the debt for a company using their own personal assets, and they are not able to, the director may face bankruptcy and disqualification from any future activities as a company director.[1]
- Immediate repayment – It will depend on the wording of guarantee agreement, however it is often general practice that personal guarantees be subject to immediate repayment if demanded by the creditor; therefore, a director will need to consider how they would satisfy the payment or obligation in a short period of time if required.
- Indemnity – Indemnity clauses are clauses that signify agreement by one party to cover the potential loss and damage suffered by another. In the context of providing a personal guarantee, it may very well be the case that a director has also agreed to indemnify the creditor against any loss suffered as a result of the default of the company (this could be in the form of legal fees, interest etc.).
- Security – Personal assets of the director may be used as security under the agreement, this means that if required (and of course depending on the size of the debt), the creditor may sell a director’s personal property to cover the debt.
Rewards to requesting personal guarantees
On the contrary, businesses who regularly enter any of the contacts referred to above, may want to consider requesting personal guarantees from directors if entering an agreement with a company.
The significant advantages to requesting a personal guarantee are:
- Security for payment – If the company which the agreement with cannot pay its debts or fulfil its obligations under the agreement, the personal guarantee can provide an additional form of securing payment; and
- Skip the que – If the company goes into liquidation, the business will likely have no recourse against the directors of the company and payment would depend on the rules of priority of payment upon liquidation of the company. This may mean that by the time the company’s debts (that require priority payment before your business) have been paid, there may be no money left to pay your business. A personal guarantee will allow a business to pursue the guarantor personally and access their personal assets to satisfy the debt if required (and if stipulated by the agreement), instead of waiting for the completion of the liquidation of the company.
- Leverage – Having a personal guarantee can give you a great leverage in negotiations if a corporate debtor is having financial difficulty to meet debt payments.
How can Lynn and Brown help?
Personal guarantees can pose considerable personal risk to the guarantor. If you are the director of a company and you have been asked to provide a personal guarantee, we highly recommend seeking legal advice prior to signing any agreement.
Our commercial team at Lynn and Brown Lawyers regularly review and advise on the provision of personal guarantees. We can assist by examining and giving you advice about your rights, obligations, and potential risk under any agreement to provide a guarantee, suggest any amendments we consider appropriate, or negotiate the terms of the guarantee on your behalf.
Further, personal guarantees can be a useful resource for those who invoice their clients in arrears, or trade with entities which hold little to no assets. The law in regard to personal guarantees is very technical, we regularly see people incorrectly create a personal guarantee that can be enforced due to being incorrectly worded. The benefits of a personal guarantee are most evident when seeking to enforce a debt owed to your business. A carefully drafted guarantee can provide added protection to ensure obligations a business has been promised under an agreement are met, either by the company, or by virtue of enforcing the guarantee.
Our commercial team at Lynn and Brown Lawyers also regularly draft and advise on appropriate guarantees that your business can use to ensure maximum protection under an agreement. Businesses who are looking to have a higher rate of debt recovery, or to mitigate their risk of exposure in business arrangements, our commercial team can assist you to achieve this.
[1] see Section 206B of the Corporations Act 2001 (Cth).
About the Authors: This article has been co-authored by Chanelle Kane and Steven Brown. Chanelle has been in the industry since 2013 and graduated with a Bachelor of Laws in 2020. Chanelle completed the Graduate Diploma of Legal Practice with the College of Law in 2020 and was awarded the 2020 PLT Professional Excellence Award for the cohort. Chanelle was admitted to practice in the Supreme Court of Western Australia in November 2020 and to the High Court of Australia in January 2021. Steven is a Perth lawyer and director, and has over 20 years’ experience in legal practice and practices in commercial law, dispute resolution and estate planning.
