If you operate your business through a company or a trust, you may be called upon from time to time to provide a personal guarantee.
What is a Personal Guarantee?
A personal guarantee is a commitment that if your business doesn’t do something (usually the payment of money) you will do that thing yourself. Personal guarantees most often arise where you are seeking finance from your bank or when you are entering into a lease for your business premises.
Case Study – Personal Guarantees under a Lease
Two of my clients carried on a fast-food franchise business in partnership. One partner had recently decided to sell his interest in the business to the other partner.
Whilst the business lease was held in the name of their franchisor, they had each provided personal guarantees under the lease given they were the actual occupants of the premises.
When my clients came to see me to negotiate with their landlord for the release of the outgoing partner’s personal guarantee, they were unaware that the landlord was under no obligation to do so. In fact, under the current situation:
- If they sold their business to a third party who continued to occupy the premises under the franchisor’s lease from the landlord, my clients could be held personally liable for any breaches of the lease by that third party; and
- If the franchisor assigned the lease to a third party, my clients could be held personally liable for any breaches of the lease by that third party.
In essence, their personal guarantees would only be released when the lease expired.
What should I do if I have to sign a personal guarantee?
I recommend all my clients ensure they have a thorough understanding of the following before providing a personal guarantee:
- Make sure you understand the limit of your Guarantee. Your personal guarantee will secure a specific obligation or set of obligations such as to repay a loan or comply with a lease. It is essential you review the relevant loan or lease terms before providing the guarantee. If the person you are providing the guarantee on behalf of breaches these terms, compliance with them will become your responsibility. Guaranteeing the repayment of a $10,000 loan is drastically different from guaranteeing the repayment of a $10,000,000 loan.
- Make sure you understand how your personal guarantee will be released. Most banks will refuse to release a personal guarantee until the loan that it secures has been repaid in full. Most landlords will only release a personal guarantee on the expiry of the lease. That being said, if you can satisfy the bank or landlord that the probability of the borrower or tenant defaulting in its obligations is low, or that the borrower or a third party can provide substitute security of equal value, you can in some circumstances negotiate for the earlier release of your guarantee.
- Make sure you understand who you are providing the personal guarantee on behalf of. As outlined in the above example, my clients made the mistake of assuming they were providing personal guarantees on behalf of their partnership. They were in fact providing a personal guarantee on behalf of their franchisor.
- Investigate the person or entity you are providing the personal guarantee on behalf of. Your personal guarantee will only be called upon if the person or entity you have provided it on behalf of defaults in its obligations. You should investigate and make your own assessment as to the likelihood of this occurring before providing your personal guarantee.
It is essential you obtain legal, accounting and financial planning advice before providing a personal guarantee. Please don’t hesitate to contact me if you need advice on a personal guarantee.