Corporate insolvency, including the latest Small Business Restructure (SBR) process, often has wide reaching implications for directors that may not be known until it is too late and financial difficulty arises.
Generally speaking, directors are not liable to pay company debts; there are however some exceptions, including when a personal guarantee is provided for the company’s debt.
So, the question is, do you really know what you are signing when it comes to providing a personal guarantee?
We often encounter directors who are surprised about the implications of signing a personal guarantee. Below we have explained some of the key aspects of personal guarantees that are often missed.
What is a personal guarantee?
A personal guarantee is a legal commitment by an individual (usually a company Director) to pay a debt primarily owed by another party (a company or other individual) if that party does not pay the debt.
Most people understand the basic concept of providing a personal guarantee but there can be some unintended and unexpected consequences.
Supplier Accounts
To provide goods and services on credit to a company (i.e. a credit account), a supplier will usually provide a credit application form along with their accompanying terms and conditions.
A personal guarantee (PG), with its own terms and conditions, may also be required by the supplier to open the credit account in which the guarantor (usually the Director) will guarantee payment of any outstanding invoices if the company does not pay them in full (if for example, the company is placed into liquidation). There can also be liability for interest and costs incurred by the supplier.
Imbedded in the detail of the terms and conditions of the PG, is often a term commonly referred to as a “Charging Clause”. That Charging Clause will say something to the effect of “the Guarantor charges all of their real and personal property to secure payment of the money owed pursuant to the guarantee they have provided”.
The terms and conditions of the PG will also usually permit the supplier to lodge a caveat on the title of any real property to secure payment of the debt pursuant to the Charging Clause. Upon an insolvency event, such as the liquidation of a company, it is not uncommon for these parties to immediately register caveats on any real property owned by a guarantor. So effectively, when you sign the PG you can be giving security over your property, like a mortgage to a bank!
Banks and Financiers
General Secured Loans
Banks and major financiers will often obtain security against real property for loans and finance facilities provided to companies that operate small to medium businesses.
These loans (e.g. an overdraft facility) will often be secured by real property that may be owned by the primary borrower (the company) or a Director personally through a personal guarantee (such as their family home). The security is normally provided in the form of a registered mortgage; so, as a Director, you would be well aware the bank or financier will have rights to enforce payment of the debt owed by the company against the mortgaged property.
Specifically Financed Assets (Chattel Mortgages / Finance Agreements)
If a bank or financier has provided funding to a company to purchase a specific asset (such as a motor vehicle), they will usually also obtain a personal guarantee from a Director.
Whilst the bank or financier will normally obtain security against the asset purchased (the motor vehicle), if the company defaults on payment of the finance payments, the financier can repossess and sell the asset. If after the sale of the asset there is not enough money to pay the debt owed to the financier, the balance owed is referred to as a Shortfall Amount. There can also be liability for interest and costs incurred by the financier which can be added to the Shortfall Amount.
This Shortfall Amount can be pursued by the bank or financier against the guarantor. Again, as for the earlier examples, this personal guarantee may contain a Charging Clause which would entitle the bank or financier to be secured against property owned by the guarantor and to lodge a caveat against the property.
Unsecured Loans
There are some financiers and lenders that specialise in providing loans to companies that do not require a company to provide any security against its assets.
That does not mean they do not obtain any security at all though.
These financiers and lenders often seek personal guarantees from the directors of the company (and sometimes other family members). Those same Charging Clauses noted above can form part of this personal guarantee.
The practical implications of this are that instead of providing security against the company, a Director (or other family member) may have inadvertently provided security against their personal property (such as their family home) if the company cannot pay the debt.
Takeaways
Personal guarantees are sometimes a necessary part of business. It is however always best to properly consider and obtain advice on the terms and conditions of personal guarantees before they are signed, regardless of the urgency of obtaining funding or finance. If no longer involved in the business, the director must inform the suppliers and financiers and seek the release of the guarantee.
If you or your client are facing financial difficulty and personal guarantees have been provided for company debts, we encourage you to reach out to your local SV Partners’ office for appropriate advice – your assumptions may not be correct.
Article written by Daniel Luckman (Associate Director) – Sunshine Coast