Personal Guarantees - Why you need to use them and how
Personal guarantees are one of the most useful tools a business can implement to ensure that it is paid by its customers promptly. A personal guarantee makes an individual (usually the director of a company) personally liable for the debts of the company. Amending trading arrangements and standard form agreements to include a guarantee is an easy step that can greatly increase the amounts recovered in the event that the corporate customer is unable to pay or experiences financial difficulty.
2020 was a difficulty year for many businesses in Australia and many of those businesses are still feeling the impact from COVID-19 and the associated economic downturn.
The protections put in place by the federal government allowed many businesses that would otherwise have failed to keep operating with the benefit of JobKeeper payments and protections from debt enforcement processes.
The reduction of JobKeeper payments and easing of protections has some commentators predicting a surge in business insolvencies. To address this surge, the federal government has introduced small business restructuring and simplified liquidation processes to allow small businesses with less than $1 million in liabilities to restructure or wind up in a quicker and more cost-effective way – see our page in relation to these processes here.
It is against this backdrop of impending business insolvencies that we are reminded of the importance of personal guarantees to creditors advancing funds to companies. This article addresses some of the key elements of personal guarantees and highlights how important they can be for a creditor when the company is loaned money when experiencing financial difficulty.
What is a Guarantee?
In short, a guarantee is a promise to answer for a third party’s obligation. Commonly, a creditor of a company will seek a guarantee from the director of that company in relation to amounts owing by the company to the creditor. This arrangement ensures that a natural person is ultimately responsible for the debt of the company.
A guarantee is often coupled with an indemnity in favour of the creditor where a person agrees to indemnify the creditor from any loss suffered by reason of the actions of a third party.
The obligations in a guarantee and those in an indemnity are different and result in a difference in the nature and extent of the obligations assumed.
Importance of Guarantees (and Indemnities)
When dealing with a company, the existence of a guarantee and indemnity by an individual can be invaluable. This value of a guarantee and indemnity is often revealed when the company enters external administration and the creditor is left to prove in the liquidation or administration together with other unsecured creditors.
In a liquidation or administration a creditor with a guarantee from the director of a company has the added leverage of being able to seek recovery under their guarantee and indemnity. In our experience, creditors with a personal guarantee are more likely to see a greater return than those creditors left to prove in the liquidation.
Even better protection is achieved when a guarantee is coupled with a charging clause giving the creditor the power the lodge a caveat over real property of the guarantor.
What to do now?
Creditors should be reviewing their trading arrangements and standard form agreements. Where the trading partner is a company, the standard form agreements entered into should seek a personal guarantee from a director of the company. Where the trading partner is an individual, consider seeking a personal guarantee from their spouse to further increase your security position.
Where your standard form agreements do not contain a guarantee, you should consider amending them as soon as possible. If there are any trading partners that are in financial difficulty, you should consider making a personal guarantee a condition of further credit.
We often see guarantees and terms and conditions drafted poorly, which leads to uncertainty of outcomes and increased cost when it comes time to try and recover amounts owing. Using an experienced solicitor to draft your standard terms and conditions or stand-alone guarantee allows a business greater certainty that it will recover amounts advanced to its customers.
How Can We Help
If you are considering the use of a Guarantee or Indemnity for your business, contact Roberts Legal on 02 4926 2236 or email firstname.lastname@example.org to speak directly with Tony for a Free Case Evaluation.