Business is inherently risky, so people look for ways to protect their interests when entering into new contracts. A common business practice is to ask for a personal guarantee if money is exchanging hands. This could apply in a loan contract, or for the sale of a business. If you make a personal guarantee for someone else (the debtor), then you (the guarantor) are promising the lender/seller (the guaranteed party) that you can personally pay back what the debtor owes, if they cannot. It is a big commitment, and you should think carefully about all of your possible options before making a personal guarantee. This article will explain what a personal guarantee is, and things you should consider when signing one.
What Is a Personal Guarantee?
When you make a personal guarantee, as the guarantor, you promise that you can personally cover the debt that a borrower or buyer takes on. You take on the obligation of fulfilling their contract, providing a guarantee that they can hold up their end of the bargain. If they are unable to, then it is your responsibility to pay back what they owe and fulfil the contract.
This does not just apply to third parties. As a business owner, you can promise to be personally liable for any debt the business incurs.
A personal guarantee provides security for the guaranteed party, especially if the debtor is inexperienced or does not have reliable credit. The minimum requirements are that the:
- contract with the guarantee must be in writing; and
- guarantor signs this personal guarantee.
You would usually draft a provision in a contract outlining your personal guarantee if you have to give one. Providing such a guarantee may also indemnify the guaranteed party against any losses that happen due to the debtor’s inability to hold up their end of the deal. On top of the initial sum of money, you may need to pay their legal fees or interest costs as well.
When Would I Require a Personal Guarantee?
Personal guarantees are common across the commercial sphere. You can use them in a variety of situations. These include:
- directors or shareholders giving a guarantee for a company’s debts;
- banks requiring a guarantor for a business or home loan;
- landlords asking for a guarantee for leasing business premises;
- suppliers requiring a guarantee as part of your supply contract; or
- franchising agreements.
Sometimes, when your company enters into business deals, the other party may request a personal guarantee from your directors or shareholders. They are then personally liable for whatever debt they promise to cover. If the company becomes insolvent or goes into liquidation, the other party can still claim their debts.
What Does It Mean When I Sign a Guarantee?
Personal guarantees are legally binding, which means that you must pay if the debtor cannot. If you do not, then the guaranteed party can potentially bring proceedings against you in court. They would likely send you a letter of demand first to both you and the debtor, requiring your payment.
You personally bear the risk according to the guarantee that you sign. This means that your personal assets could be at risk because you may have to sell them to pay back the debt. You should note that the guaranteed party does not have to necessarily rely on the debtor first to fulfil their obligations according to the contract. If there are outstanding funds, they can go straight to you first without making a claim against the debtor beforehand.
Note: In some instances, there may be multiple guarantors involved. When this is the case, you are all jointly and severally liable. This means that the guaranteed party can require one of you to pay the full amount owed, or make an equal claim against each of you.
Things to Consider
There are a few things that you should consider or do before making a personal guarantee. These include:
- taking the opportunity to get independent legal advice before signing a personal guarantee. A lawyer can explain what your liabilities are, and help you negotiate;
- making sure you thoroughly read through the conditions of the guarantee;
- taking care to ensure the debtor can fulfil their end of the bargain. Do your due diligence and check their history;
- protecting your personal assets in some way. For example, placing your home in a family trust means that a lender likely cannot claim it when they ask for repayment;
- negotiating where possible to make the guarantee for a limited time or amount of money. If you can prove reliability for that time or amount, it means the guarantee is not an ongoing obligation; and
- avoiding a personal guarantee altogether if you can prove that you (if you are the debtor) have a reliable experience and a good trading history.
Key Takeaways
A personal guarantee is a promise you make to fulfil another party’s obligations in a contract if they cannot do so. This could be you personally guaranteeing to cover the debts your business takes on. This is not a decision you should make lightly, so it is a good idea to get experienced help to make sure you are in the best position to make such a decision. If you would like more information or help with your personal guarantee, contact LegalVision’s New Zealand contract lawyers on 0800 005 570 or fill out the form on this page.
Frequently Asked Questions
It is a promise to cover someone else’s debt should they be unable to pay. You take on their obligations if they cannot fulfil their side of the contract. It is essentially a fallback to make sure the contract is performed.
You may need one if another contractual party wants someone to be personally liable for your company’s debts to that person. Or, a landlord may require a personal guarantee for paying your rent.
Someone may ask you to provide a personal guarantee if you lack experience, or do not have a reliable trading history. A guarantee acts as a security so that they know they can still be paid if you cannot fulfil the contract.
If you include a personal guarantee in a contract, and sign that contract, then it is legally binding. If a creditor asks you to pay what you promised, you must do so. Otherwise, you may face legal penalties.