When buying a business, the seller/ landlord/ shareholder may require you to provide a personal guarantee in the contract of sale or lease. A personal guarantee is a legal commitment made by an individual, typically a business owner or executive, to take on personal responsibility for a loan if the business is unable to repay its debt. This means that if the business defaults, the guarantor is personally liable for satisfying the debt, potentially using their personal assets.
Personal guarantees are common prerequisites for obtaining business loans, especially for new or financially unstable companies, providing lenders with a layer of security against the risk of non-payment. By requiring a personal guarantee, lenders mitigate the risk associated with lending to businesses that might be new or have a less stable financial history. Once signed, a personal guarantee becomes a legal obligation, and if the business fails to meet its loan repayments, the guarantor must cover the debt from personal resources.
What Does it Mean to Give a Personal Guarantee in Business Purchases?
A personal guarantee is a legal commitment made by an individual, typically a business owner or executive, to take on personal responsibility for a loan if the business is unable to repay its debt. This means that if the business defaults, the individual is personally liable for satisfying the debt, potentially using their personal assets.
In a personal guarantee, there are three parties involved:
- Party A and Party B – the two parties to the agreement
- The Guarantor(s) – the person giving the guarantee, who promises to Party B that they will fulfil Party A’s obligations under the agreement if Party B does not fulfil them
A personal guarantee integrates an extra layer of security for lenders by binding an individual’s personal assets to the business’s loan obligations. By requiring a personal guarantee, lenders mitigate the risk associated with lending to businesses that might be new or have a less stable financial history. Once signed, a personal guarantee becomes a legal obligation. If the business fails to meet its loan repayments, the guarantor must cover the debt from personal resources.
Personal guarantees are important for businesses of all sizes, but increasingly so for those who invoice their clients in arrears, or trade with entities which hold little to no assets. The benefits of a personal guarantee are most evident when seeking to enforce a debt owed to your business. For example, when seeking to recover a debt from a company that is in liquidation, the individuals guaranteeing the contract cannot hide behind the failing company, meaning that your debt will still be recoverable from those guarantors despite the insolvency of the company you were trading with.
A personal guarantee can be incorporated into almost any commercial agreement, including but not limited to:
- Leases
- Trade and supply agreements
- Loans and other financing arrangements
- Sale contracts for land, business, shares, or any other property
- Building and construction contracts
If a personal guarantee is incorrectly prepared or inappropriately disclosed to the guarantor, it may be rendered legally unenforceable. To ensure your personal guarantee is enforceable and binding on a guarantor it is essential that you engage a commercial lawyer to prepare the guarantee for you.
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Common Requirements for Personal Guarantees
Personal guarantees often come with specific requirements and clauses that the guarantor must agree to. Understanding these common business laws and contractual provisions is essential for anyone considering signing a personal guarantee.
One typical requirement is that the guarantor assumes full liability for the debt or obligation being guaranteed. This means if the primary debtor fails to pay or perform, the guarantor becomes responsible for the entire amount owed, regardless of their ownership stake or role in the business.
Personal guarantees may also include clauses that make the guarantor’s liability “joint and several.” In this arrangement, the lender can pursue the guarantor directly for repayment without first exhausting remedies against the primary debtor or any other guarantors. Each guarantor is individually responsible for the full debt.
Another common provision is a “continuing guarantee” clause. This means the personal guarantee remains in effect indefinitely, covering not just the original debt but also any future obligations between the borrower and lender. The guarantee continues until it is explicitly revoked or the underlying debt is fully satisfied.
Lenders may also require guarantors to pledge personal assets as collateral to secure the guarantee. This could involve granting the lender a lien on real estate, vehicles, or other valuable property. If the debt goes unpaid, these assets could be seized to satisfy the obligation.
Some personal guarantees contain “acceleration” clauses. If triggered by a default or other specified event, this provision makes the entire debt balance immediately due and payable. The guarantor becomes responsible for the full accelerated amount rather than just the missed payments.
Finally, many personal guarantees include waivers of legal rights and defences. Guarantors may be asked to waive rights to notices, protests, or even the requirement that the lender first pursue the primary borrower before seeking payment from the guarantor. These waivers can significantly impact a guarantor’s ability to defend against collection efforts.
Types of Personal Guarantees
Unlimited Personal Guarantees
An unlimited personal guarantee places the guarantor in a position of maximum liability for a business loan. Under this type, the guarantor becomes responsible for the entire amount of the loan, including additional fees, legal costs, and accrued interest. This form of guarantee is particularly common for sole business owners and single proprietorships, where the owner must take full responsibility for business debts.
Limited Personal Guarantees
A limited personal guarantee introduces a cap on the guarantor’s liability, making it particularly relevant when multiple owners are involved in a business. This type restricts individual risk by distributing the liability among guarantors according to predetermined percentages. For example, if there are two business partners with equal ownership stakes, each might be responsible for 50% of the loan amount under a limited guarantee.
The key difference between these two types lies in the level of personal risk and financial exposure. While unlimited guarantees may result in more favourable loan terms due to the comprehensive security they offer lenders, limited guarantees provide safeguards by restricting the guarantor’s liability to a specific amount or percentage.
Risks and Consequences of Providing a Personal Guarantee as per Business Law
A personal guarantee creates significant financial exposure for the guarantor. When signing a personal guarantee, you become personally responsible for meeting the guaranteed obligations if the primary party defaults.
Personal guarantees put your individual assets at risk. If the business fails to meet its obligations, the creditor can pursue your personal savings, investments, and property to satisfy the debt. This means your family home and other personal assets could be seized to cover business debts.
The liability under a personal guarantee is often unlimited. Unless specifically capped, you may be responsible for the full amount of the debt plus additional costs like interest, legal fees, and other charges that accumulate. Many guarantees are also continuing, meaning they cover both current and future debts to the same creditor.
Personal guarantees can impact your ability to obtain financing. Banks and lenders consider personal guarantees as contingent liabilities when assessing loan applications. This additional risk exposure may make it more difficult to secure personal loans or mortgages.
Charging clauses in personal guarantees create additional risk. These clauses allow creditors to place a caveat over any real estate you own as security for the guaranteed debt. This restricts your ability to deal with your property without the creditor’s consent.
The duration of personal guarantee liability can extend well beyond your involvement with the business. Simply resigning as a director or selling your ownership stake does not automatically terminate a personal guarantee. You must specifically negotiate a release with the creditor.
Default under a personal guarantee can severely damage your credit rating. If legal action is taken against you as guarantor, any court judgements will appear on your credit report and impact your ability to obtain credit in the future.
Legal Advice and Negotiation Strategies
Importance of Legal Advice
Professional legal guidance on commercial law is essential when dealing with personal guarantees to protect your rights and understand your obligations. A business lawyer can review the guarantee terms, explain potential risks, and identify areas for negotiation. They can also assess whether the guarantee contains unreasonable clauses, such as extensive charging provisions that could put your personal assets at risk.
Legal advice is particularly valuable for understanding complex aspects like charging clauses, which may allow creditors to place caveats over your property. A lawyer can help determine if such clauses are valid and enforceable based on your specific circumstances.
Negotiating Terms of a Personal Guarantee
When negotiating a personal guarantee, several key strategies can help minimise your personal risk:
- Cap the maximum liability at a specific dollar amount
- Include an expiry date to limit the duration of the guarantee
- Request the removal of charging clauses that create security interests over your assets
- Negotiate a reasonable interest rate for any amounts that become owing
- Seek proportional liability if multiple guarantors are involved
- Include conditions for the guarantee’s release if you’re no longer involved with the business
The strength of your negotiating position will depend on factors like your relationship with the other party and the commercial importance of the guarantee. For example, if you’re a director leaving a company, you should request to be released from any personal guarantees since you’ll no longer benefit from the business relationship.
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Alternatives to Personal Guarantees
While personal guarantees are a common requirement for business loans, there are alternative options that businesses might consider to secure financing without putting personal assets at risk. These alternatives can provide a way to obtain necessary funds while limiting personal liability.
One potential alternative is offering collateral instead of a personal guarantee. Collateral refers to specific assets, such as equipment, inventory, or real estate, that the lender can seize if the borrower defaults on the loan. By providing collateral, the business may be able to secure a loan without the need for a personal guarantee from the owner or executives.
For example, if a company owns valuable machinery or a fleet of vehicles, these assets could be used as collateral for a business loan. The lender would have the right to take possession of the collateral if the company fails to repay the loan according to the agreed terms.
Another option is to explore business credit insurance or loan default insurance. These insurance products can protect the lender against losses if the borrower is unable to repay the loan. By purchasing this type of insurance, the business may be able to negotiate a loan without the requirement of a personal guarantee.
In some cases, businesses might also consider alternative financing sources that don’t typically require personal guarantees, such as crowdfunding, grants, or equity investments. While these options may not be suitable for every business, they can provide a way to access capital without putting personal assets on the line.
Ultimately, the availability and feasibility of alternatives to personal guarantees will depend on the specific circumstances of the business, including its financial health, credit history, and the type of financing sought. It’s essential for business owners to carefully explore all options and seek professional advice to determine the best course of action for their unique situation.
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Personal guarantees are significant legal commitments that require careful consideration before signing. Understanding their implications, from the types of guarantees available to negotiation strategies and alternatives, is crucial for making informed business decisions.
A well-structured approach to personal guarantees involves seeking professional legal guidance, thoroughly reviewing terms, and exploring potential alternatives that may better suit your business needs. Whether providing or requesting a personal guarantee, the key is to balance risk mitigation with practical business requirements.
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