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Negotiating scope and limiting exposure of guarantor essential
Personal guarantees are often given by directors and shareholders to secure the obligations of a company. Put simply, the individual assumes responsibility if the company is unable to pay its debt.
Providing personal guarantees can be essential for doing business and may be a pre-requisite for unlocking additional benefits such as cash flow. However, a personal guarantee is a significant obligation and should be approached with care.
It is key to understand the nature and scope of the guarantee and to ensure the obligations of the guarantor are understood to limit potential exposure.
The scope and liability of a personal guarantee
A personal guarantee creates a primary obligation on the guarantor. This means the creditor can enforce the guarantee against them without first being required to claim against the company.
Many guarantees effectively put the guarantor in the place of the company under the head agreement. For this reason, it is important to understand the financial position of the company before providing a guarantee.
If there are multiple guarantors, they will usually be jointly and severally liable for the amount owing. This means that the creditor can pursue one guarantor alone for the total amount and is under no obligation to pursue any other guarantors or make them pay a share of what is owed. Alternatively, the creditor can choose to pursue all the guarantors jointly.
If a guarantee is unlimited, the guarantor will be personally liable for all amounts owed by the company currently as well as future borrowings, debts or obligations. Lawyers will often negotiate limits on the time period and monetary “cap” of personal guarantees.
The liability may remain in place even if the company has assigned the relevant contract to another entity. For example, this is commonly seen in the context of a lease assignment.
Problem areas of personal guarantees
Ceasing to act as a director or shareholder of a company does not automatically terminate a guarantee. The guarantor needs to negotiate to obtain releases of the guarantee and a creditor will often request a replacement guarantee from someone else such as a director or shareholder of an incoming tenant company.
The guarantor’s personal assets can be in danger in certain situations. They need to consider whether they are comfortable with having their personal assets exposed (and potentially lost) if a claim is made against them. An asset protecting strategy, which includes transferring assets into trust, will help protect personal assets.
The guarantor also needs to consider the directors’ duties under the Companies Act 1993 as the guarantee may put the individual in a position where there are conflicts of interests with the company.
Alternatives to a personal guarantee
If we use a lease as an example, a landlord may require a combination of a bond, bank guarantee, and a personal guarantee as security for the tenant company’s obligations.
The weaker the tenant’s ‘covenant strength’, the greater level of security the landlord will likely require. If the requirement for a personal guarantee seems unreasonable, based on the tenant’s circumstances, the tenant can choose to push back on the requirement by offering a bank guarantee that has a certain time period and/or monetary limit.
However, the ability to do so depends on the bargaining power of each party.
Obtain legal advice
Personal guarantees can be lengthy, complex documents littered with legal jargon, which is why it is important to seek independent legal advice before signing the agreement.
While avoiding personal guarantees may be the ideal situation, it is increasingly difficult to do business without being willing to provide them.
As mentioned earlier, it is essential to negotiate the nature and scope of the guarantee and seek expert advice about how to limit an individual’s exposure.
Haigh Lyon has experience negotiating personal guarantees for clients. For more information contact Raj Gurusinghe on 09 306 0629 or [email protected] or Melinda Whyte on 09 985 2531 or [email protected]