3 Things All Subbies Should Know About Personal Guarantees
Updated: Dec 24, 2019
If you want an account with a supplier or a business loan, a personal guarantee is an unfortunate standard requirement. But that does not mean you should resign yourself to the risk and not question how the guarantee is written or think about it ever again once signed. Unchecked and forgotten personal guarantees can take on a life of their own. So this article discusses three vital things you need to know about personal guarantees.
But first what is a personal guarantee?
A personal guarantee is essentially a legal promise that you will repay a debt personally if your business fails to do so, and they are common in supplier account applications in the building and construction industry.
Personal guarantees are designed to protect the lender or the supplier of goods and services if the business is unable to pay back its debt.
In other words, your personal finances are the supplier’s security for the business’s debt. This can have a serious impact on you personally if the business defaults. Like any unpaid debt, an unpaid personal guarantee can cause your credit rating to be affected or at worst, it can cause you to go bankrupt.
1. The credit limit can increase without your consent
When you sign a personal guarantee, the terms may be vague and allow for credit to be increased without any requirement to inform you or seek your approval, in your capacity as guarantor, of the increase.
Say, for example, when you signed the personal guarantee, the business was seeking credit of $10,000. At the time, this was not a large risk for you financially, but later, without your knowledge, someone within the company applies for a credit increase or the supplier allows the business credit account to creep up as the business and account history grows. Years later, you realise you have a personal guarantee for $150,000, which is a substantial risk for you.
When signing a personal guarantee, it is important to watch out for:
If the personal guarantee is not limited to an amount; and
If the personal guarantee document allows the supplier or financier to increase the amount guaranteed without you being notified.
If the credit limit can be increased without your knowledge or consent and the business doesn’t pay amounts due under the supply arrangement, you could then find yourself liable for a lot more than what you originally signed up for.
2. The personal guarantee does not stop when you leave the business
Guarantors (people who sign personal guarantees) will often think that their obligation ends when they leave the business. This is not always the case, even being removed from the ASIC company register as a director does not mean that your obligation to honour the personal guarantee has been removed.
The process for having the personal guarantee terminated will depend on the terms of the personal guarantee document. However, it is more than likely that to make sure that your liability under a personal guarantee ends, you will need to terminate the guarantee by giving notice to the supplier or financier.
Please note, this will probably not remove your liability to pay debts that have accrued before you give notice, but it should protect you from future liabilities. This means that if you leave a business, you should terminate your personal guarantees as soon as possible to avoid being liable for any additional debts.
3. Often the guarantee allows a charge to be put over your personal assets (including your house)
Many guarantees will include a clause that puts a charge over your personal assets, like your house or car, if you don’t satisfy a debt.
For example, a typical supplier’s personal guarantee states:
“I [the Guarantor] understand that if the Customer fails to make any required payments to the Supplier, the Supplier may recover the amount of these payments from me personally. In this case the Supplier may, amongst other recovery rights, take a charge over any real property that I have a legal or equitable interest in.”
The effect of this clause is that if the customer doesn’t pay the account, the supplier can put a charge on any land held by you, the guarantor, can register a caveat over that land and become a mortgagee. If debts subject of the credit account are not paid, you could lose your house.
Before you sign....
Before you sign a contract or agreement, check whether it has a personal guarantee. This may be a clause or it could be a separate document like a deed. Make sure you read the small print and if you are unsure of what it all means, please seek legal advice before you sign anything.
It’s always best to avoid giving a personal guarantee. But if that’s not an option, at least try to limit your liability to specific amounts or transactions, or an overall capped amount. You want to avoid signing anything that guarantees “all monies”, like the clause in the supplier example above.
And finally, it’s always best practice to keep a copy of any agreement or credit application that you sign. This way, you know your liabilities, but also, if you leave a company, you can keep track of any guarantees you’ve signed so that you can take the necessary steps to terminate them.