Personal guarantees are a feature of everyday commercial transactions covering everything from repayment of loans, payment for services and goods, and the performance of obligations. It would be unusual that a director of a trading company has not at some time been required to provide a guarantee in connection with the commercial activities of their company. However, just because they are commonplace or ‘industry standard’ does not mean that guarantees should not be treated with respect and caution. It will be a very rare occurrence that the question ‘do you remember that guarantee you gave?’ will be followed by good news.
Banks, suppliers and service providers seek personal guarantees from directors not only to ensure that there are sufficient assets available to repay the loan or to pay outstanding invoices but also to ensure that those operating the company have sufficient ‘skin in the game’ to ensure that the company performs its obligations.
All guarantees are not the same
Whilst most guarantees will have the same effect, there is no ‘standard’ form of personal guarantee. This means that each document should be read carefully to ensure that no unusual terms have been included, such as clauses that have the effect of charging all of the guarantor’s property with repayment of the debt.
Do directors guarantees cease when the person is no longer a director?
Unless specific arrangements have been agreed and incorporated in the guarantee, a director who has given a personal guarantee is generally not relieved of their obligations when they cease to be a director. This means that retiring directors should obtain releases from the banks, suppliers and service providers that they have provided guarantees to. An indemnity given by a company to a retiring director will usually be insufficient protection because the guarantee will generally only be called on in circumstances where the company has already defaulted on its obligations (meaning the indemnity is probably worthless).
There is generally no time limit on a guarantee
Most guarantees given to suppliers, service providers and banks are continuing guarantees and will cover all amounts owing from time to time. As such, they are not limited to specific transactions or time periods. This means that for so long as that supplier or bank is owed any money, the guarantee can be called upon. Even when there has been a long time between the granting of the guarantee and a claim being made, the guarantee can still be enforceable.
Does the lender or supplier have to sue the company first?
A guarantee is a contractual promise to fulfil the obligations of a third party, meaning that the holder of the guarantee must usually take action against the company before invoking the guarantee. However, most guarantees given to suppliers, service providers and banks also contain an indemnity. The indemnity creates a primary obligation between the guarantor and the supplier/bank, the effect of which is to enable the supplier/bank to claim against the guarantor without first having to take proceedings against the company. There are exceptions under the National Credit Code where the guarantee is given in connection with residential property or for other personal, household or domestic purposes, but these exceptions are unlikely to apply to commercial business transactions.
Unless a specific arrangement has been agreed and incorporated in the guarantee, the liability of a partner who gives a guarantee in respect of the liabilities or obligations of the partnership is not limited to, or proportional to, their interest in the partnership. Most guarantees will seek to make each of the partners in the partnership entirely liable for the guaranteed amount. Consequently, a junior partner in a partnership who has substantial assets could be pursued for payment before a senior partner is.
It is important to read and understand the obligations and liabilities that are incurred by signing a personal guarantee. A record of all personal guarantees should be kept, together with copies of the guarantees.
It should also be remembered that it is possible to negotiate the terms of guarantees with suppliers, as they want your business too.