What is a personal guarantee?
A personal guarantee is a legally enforceable promise to fulfill an entity’s obligations if it is unable to do so. Personal guarantees are a tool available to creditors to pierce the corporate veil and hold directors responsible for their company’s debts and/or obligations.
The following article will provide three key insights all creditors should be aware of when implementing a personal guarantee in a commercial agreement.
- Have a suitable personal guarantee for the specific arrangement
Personal guarantees are widely used in commercial agreements, such as business loans, asset leasing agreements, invoice finance arrangements, trade supplies and property leases.
In high-risk industries (such as construction, hospitality or retail) it is often beneficial to include a ‘charging’ clause in an agreement, ensuring creditors’ interests are secured over any real property owned by the director. This will secure repayment priority for the creditor in a liquidation scenario.
- Ensure the guarantor can fulfil their obligations
As a creditor, it’s essential to confirm that the guarantor holds sufficient assets in their name to cover the debt if the guarantee is enforced. An iron-clad personal guarantee is of little value if the guarantor lacks the financial means to fulfill the obligations of the original agreement.
It’s advisable to conduct proper due diligence—such as running title searches and performing background checks on the guarantor—before the agreement is signed.
- Make sure the guarantee is valid and enforceable
A personal guarantee may become legally unenforceable if it is improperly drafted or not adequately disclosed to the guarantor. It is also common for agreements to be misplaced and lost. In a liquidation scenario, directors may contest the enforceability of the guarantee. Seeking assistance from solicitors experienced in the relevant industry is crucial.
The takeaway
Personal guarantees are an important protection mechanism available to creditors. In a liquidation scenario, a company’s affairs often become convoluted and litigious. It is important to have a robust personal guarantee before such events arise.
