When a business takes out finance, the lender may require a director or another individual to provide a personal guarantee.
For the business owner, this can feel like another standard piece of lending paperwork. However, a personal guarantee can create personal liability if the business does not meet its obligations under the finance agreement.
The exact level of risk depends on the wording of the guarantee, the loan documents, the security supporting the finance and the circumstances surrounding any default.
That is why it is important to understand what you are signing before agreeing to a personal guarantee.
A personal guarantee is a legally binding commitment from an individual to meet the business's obligations to a lender if the business defaults, subject to the terms of the guarantee.
For example, a company may borrow $200,000 for business equipment. The lender may require the company's director to provide a personal guarantee.
If the business subsequently defaults and the lender calls on the guarantee, the guarantor may become personally responsible for the amount covered by the guarantee.
This is important because a company is a separate legal entity. A personal guarantee can create an additional avenue for the lender to recover amounts owed from the individual who provided the guarantee.
The precise rights of the lender depend on the documents signed and the applicable law.
Personal guarantees provide lenders with additional security when lending to businesses.
This is particularly common in small and medium-sized business lending, where the business may have limited assets or trading history.
A lender is assessing the risk that the business will repay the finance. A personal guarantee provides an additional commitment from the individual behind the business.
This does not necessarily mean the lender expects the business to fail. It is often simply part of the lender's standard commercial lending requirements.
Depending on the finance structure, a lender may require a personal guarantee even where the loan is also secured against an asset.
One of the most important things to understand is whether your guarantee is limited or unlimited.
A limited guarantee places a specified limit on the guarantor's liability.
For example, a guarantee may be limited to $100,000.
The exact calculation of the liability can depend on the wording of the guarantee, including whether interest, fees and enforcement costs are included within or outside the stated limit.
An unlimited guarantee does not place the same fixed dollar cap on the guarantor's liability.
Depending on the document, the guarantee may cover the outstanding debt as well as interest, fees and certain enforcement costs.
This is why you should never assume that signing a guarantee for a $200,000 business loan means your maximum personal exposure is automatically $200,000.
Always have the actual guarantee reviewed by a solicitor before signing it.
If more than one person provides a guarantee, the document may state that liability is "joint and several."
This can be particularly important for businesses with multiple directors or owners.
Joint and several liability can mean that each guarantor may be responsible for the full guaranteed amount, rather than simply their percentage of the business.
For example, two directors may each own 50% of a company. That does not necessarily mean each director is only responsible for 50% of the guaranteed debt.
The exact position depends on the guarantee document.
If you are signing alongside another director or shareholder, do not rely on an informal agreement about how the debt will be divided. Have the legal position explained before signing.
If a guarantee is enforced, the guarantor's personal assets may potentially be exposed, depending on the terms of the guarantee and the applicable enforcement process.
This could potentially include assets such as:
The family home can be a particularly important consideration.
Whether a lender can ultimately enforce against a particular asset depends on factors including ownership, existing security interests, the guarantee and the legal enforcement process.
A personal guarantee does not automatically mean a lender can immediately take your personal assets. However, it does create personal exposure that should be understood before signing.
Another area that deserves careful attention is an all-monies guarantee.
A guarantee may be linked specifically to one facility, or it may potentially cover broader amounts owed to the same lender.
An all-monies provision can mean the guarantee extends beyond the particular business loan you initially had in mind.
For example, a business may have an equipment loan today and later obtain another facility from the same lender.
Depending on the wording of the documents, the original guarantee may potentially extend to other amounts owed.
This is exactly the type of clause where professional legal advice is important.
Do not assume that a guarantee only covers the loan you remember discussing with the lender.
Resigning as a director does not necessarily mean an existing personal guarantee disappears.
If you have previously guaranteed business finance, you may remain liable according to the terms of that guarantee unless the lender formally releases you or the relevant obligation is otherwise discharged.
This is particularly important when selling a business, changing ownership or stepping down as a director.
If you are leaving a business, make sure you understand what guarantees you have provided and whether you have been formally released from them.
Before signing, consider asking:
These are questions to discuss with your solicitor. The answer should come from the actual documents you are being asked to sign.
If you are being asked to provide a personal guarantee, independent legal advice is strongly worth considering.
Your finance broker can help explain the commercial structure of the deal and discuss the finance options available, but a broker is not a substitute for a solicitor when it comes to interpreting the legal effect of a guarantee.
A solicitor can review the actual guarantee and explain:
Do not treat the guarantee as a formality simply because it is standard lending documentation.
The conversation about personal guarantees can start before you reach the point of signing documents.
A finance broker can help you understand how different finance structures and lenders may approach your business, including their security and guarantee requirements.
Lender requirements can vary. One lender may have a different approach to guarantees from another, particularly depending on the asset being financed, the strength of the application and the security available.
This means the lender selected can influence the structure of the finance and the documentation you ultimately receive.
However, once the legal documents are prepared, your solicitor should be the person advising you on whether you should sign them.
A personal guarantee is a legally binding commitment by an individual to meet a business's obligations to a lender if the business defaults, subject to the terms of the guarantee.
Potentially. If a guarantee is enforced, personal assets may be exposed depending on the terms of the guarantee and the applicable legal enforcement process.
A limited guarantee places a specified limit on liability, while an unlimited guarantee does not have the same fixed dollar cap. The exact scope of liability depends on the wording of the guarantee.
An all-monies guarantee can extend beyond a specific loan or facility and may cover other amounts owed to the same lender, depending on the wording of the documents.
Potentially. Resigning as a director does not automatically release you from an existing guarantee. You should obtain legal advice and confirm whether the lender has formally released you.
Yes. A personal guarantee can create significant personal obligations. Independent legal advice can help you understand the specific document and potential consequences before you sign.
A personal guarantee may be a standard part of business finance, but that does not make it something to sign without understanding.
The most important things to establish are the scope of the guarantee, whether it is limited or unlimited, whether it covers other facilities and what could happen if the business defaults.
From a finance perspective, comparing lenders and understanding their requirements can help you find a structure that suits your business. From a legal perspective, the guarantee itself should be reviewed by an independent solicitor before you sign.
At Motorlend, we can help you compare commercial finance options and understand the lending structure available for your business. When it comes to the legal terms of a personal guarantee, we recommend getting independent legal advice before signing. For a confidential discussion, get in touch.
