Increased corporate insolvency rates are leading to an unprecedented number of business owners facing requests for personal guarantees, according to DEAN FRITH, Partner and head of Baker Love’s Insolvency team.
This article gives some background on personal guarantees and provides some tips on how to deal with requests for their provision.
In Australia, the current level of personal bankruptcy and corporate insolvency is as high, if not higher, than at the height of the Global Financial Crisis. As a result personal guarantees are being sought to protect creditors’ positions. It is therefore crucial that you understand the impact personal guarantees can have if insolvency strikes.
What is a guarantee?
It is a promise by one party [natural or corporate, but usually natural] (known as the Guarantor) to meet the obligations (such as payment of monies) of another party [usually a company] (known as the Principal) where that entity fails to do so.
They are used in many commercial contexts but there are three common types of agreements where you are likely to see guarantee clauses included: leases, credit applications and loan agreements.
Most people these days operate their business either via a company or a trust which has a company as trustee. In law, directors and shareholders are separate legal entities from the company therefore operating a business in this manner means that individual directors and shareholders have the protection of what is known as the “corporate veil”, meaning that the company incurs the liability and not the individual.
While this corporate veil is increasingly being compromised by increased Director Liability laws, personal guarantees (usually from company directors) are the most common way in which entities that trade with companies, look to pierce the corporate veil – allowing them to come after the directors and their personal assets when the company fails to pay.
The number one rule: NEVER give a personal guarantee where it can be avoided.
There is no legal requirement to provide personal guarantees on any account so where possible they should be strenuously resisted. However, the current business climate in Australia means it is getting tougher to do business without being willing to provide personal guarantees, especially when looking to obtain credit.
In some situations entities will simply not do business with a company unless guarantees are provided. In that instance your next step is to try to negotiate the nature of the guarantee and here are a number of ways to do that:
- If possible, offer alternatives such as a bank guarantee or a parent or subsidiary company guarantee.
- Limit the guarantee so it only applies while you are a director of the company.
- Cap the amount of the guarantee.
- Limit the amount of time (e.g. for a lease – only the first term, not the option period).
- Make the guarantee only in favour of the party you are dealing with and not to any assigned parties.
- Make a condition of the guarantee that the Principal must be pursued first.
Exiting a business or company
Finally, one of the most fertile areas of litigation that we see is around guarantees being the basis of a claim after a Guarantor has exited a business or company.
You need to remember that providing a personal guarantee essentially has no connection with your continued relationship with the principal company or business. It is totally separate and may be relied upon by a Creditor long after you leave.
Here are a couple of tips to avoid that situation:
1. Keep a register of personal guarantees
It is easy to lose track of what guarantees have been given and on what terms. In the event of financial difficulty, such a register will be a useful tool for your advisors to assess your position.
2. Arrange for a Guarantee removal.
You must write to each creditor to whom you have given a guarantee and formally withdraw any guarantees as at a specific date and obtain confirmation of withdrawal from the creditor. This can be a complicated matter so you should get legal advice.
