A director or shareholder of a company is often asked to provide a personal guarantee of a company’s obligations.
Any person who is considering giving a personal guarantee must be aware of the risks and pitfalls of doing so.
An agreement based personal guarantee is usually either:
- set out in a separate document (eg, a deed of guarantee and indemnity)
- incorporated into the main document
Whilst in the first category above it will be obvious that a personal guarantee is requested, in the second we have reviewed many contracts where the guarantee clause is ‘buried’ in the fine print of the document.
For example, we have seen clauses in supply contracts which in effect state ‘the person signing this document on behalf of the company is giving a personal guarantee’.
Therefore, a director may sign a contract on behalf of a company and unknowingly be giving a personal guarantee at the same time!
The obvious risk in giving a personal guarantee is that the assets of the individual (which may include the family home) could be at risk if the company defaults on its obligations under the relevant contract.
Whilst the wording of the relevant document giving rise to the guarantee always needs to be considered, two key features of a guarantee are that:
- it creates a primary obligation of the guarantor, meaning that the other party can enforce the guarantee against the guarantor without first being required to claim against the debtor company
- it creates a continuing liability of the guarantor, meaning that it will only be discharged once all obligations and liabilities of the company under the relevant contract are satisfied or performed
Guarantee PLUS Indemnity
In addition, a personal guarantee is often accompanied by an indemnity whereby the guarantor essentially indemnifies the other party for all of the costs, damages, expenses and other liabilities they suffer or incur.
These amounts could prove to be substantial depending upon the circumstances.
Why are personal guarantees requested?
Two fundamental features of a company are:
- it is a separate legal entity
- it has limited liability protection
This usually means that:
- the company’s assets and liabilities are separate from its shareholders/directors
- the assets of the directors and shareholders will generally be out of reach of the creditors of the company
- in saying that, directors can be personally liable in other situations (eg, breach of their director duties, and laws that create a personal liability)
Of course, third parties who deal with a company are aware of this and so they often request personal guarantees (and indemnities) for added protection.
What should I do?
We strongly recommend a person considering giving a personal guarantee and/or an indemnity carefully consider the following:
- a person should not provide a personal guarantee and/or an indemnity where possible
- if it must be given, the relevant clauses in the contract should be reviewed by a lawyer and modified in favour of the guarantor as far as that is commercially possible
- consider lawful means of asset ownership (such as trusts)
- keep a record of all personal guarantees and/or indemnities given on behalf of the company – this will be important if the shares in, or the assets of, the company are ever sold to a third party
Please contact our commercial law team at Matthews Folbigg Lawyers on 9635 7966 if you would like advice or assistance in respect of giving or receiving (such as under your terms of trade) a personal guarantee and/or indemnity.
DISCLAIMER: This article is provided to clients and readers for their general information and on a complimentary basis. It contains a brief summary only and should not be relied upon or used as definitive or complete statement of the relevant law.