Taking precautions before committing to a personal guarantee
First published in the Jersey Evening Post – Business Supplement 15.02.23
Smaller Jersey businesses regularly need to consider borrowing money for their business, whether the reason is for start-up funding or expansion plans.
When raising funds for a business, business owners will more often than not seek to borrow money from a bank or similar.
Where the business itself is not in a position to provide security on the loan, the lender is likely to require the business owners and or directors to assume a personal liability for the loan. A personal guarantee can be crucial for businesses, allowing it to expand and improve cash flow where they otherwise would not be able to.
In essence the guarantor or guarantors will make themselves personally liable for the debt if the business were to default on its repayments to the lender. Guarantors are often aware of the risks attached to the provision of such a guarantee. However, in some cases clauses can be misleading, making it unclear what is required under the contract and/or guarantee.
It almost goes without saying that the guarantee agreement will be drafted in the interests of the lender and not the borrower. It is therefore important that the business owner and any others that have agreed to provide a guarantee only do so once they have taken legal advice and considered very carefully the implications should things go wrong.
It is too often the case that when business owners and individuals read long, legal documents, key clauses can be overlooked or skimmed over and the legal language and implications are not properly understood.
So what exactly is a personal guarantee?
This is essentially a promise from the borrower to the lender that if the business is unable to repay the money, the person providing the guarantee will be personally liable for the debt. The lender obtains security for the loan in case the business were to fail.
Offering a personal guarantee is often necessary to secure the funds needed to grow a business, but it always pays to take sensible precautions.
Entering into a personal guarantee should not be done lightly. They are binding contracts, and from the moment the guarantee is signed it becomes legally enforceable.
The majority of guarantees remain valid for years and in some cases cannot be terminated. Some may require a guarantor to meet a set of conditions before the guarantee can be terminated. The wording of each particular contract or guarantee will determine whether a guarantor can be discharged.
So what should anyone entering into a personal guarantee look for?
- What is the extent of the financial liability?
- Is the liability open ended or capped?
- Is there a time period or is it open ended?
- What would be considered a default under the terms of the guarantee?
- Is there a remedy period if there is a default on repaying?
- How would the creditors enforce the guarantee?
- Would they serve notice for monies owed, or simply demand payment?
- Are the circumstances of the guarantors personal finances or assets likely to change after the event of signing the guarantee?
- Is there any provision in the guarantee requiring that the creditor make personal demands on the guarantor only as a last resort or can they choose the business and or the guarantor or guarantors as they deem fit?
What could be the impact for the guarantor if the lender calls upon the guarantor to pay the loan back?
As stated above as a guarantor you will be legally obligated to repay the lender. As such all of your personal assets could be at risk. If you are not able to cover the debt using your own assets, or your fellow guarantors cannot assist in paying the debt, you could end up losing your home and or facing en desastre (bankruptcy) proceedings. Moreover, you could as well possibly be disqualified from future activities as a company director. Even if things don’t get that serious, you may experience a negative effect on your credit rating which may have a knock on effect on your business.
All in all, if you are considering whether to sign a personal guarantee you should always take independent legal advice and consider what the terms mean and how it may impact you, your finances and your family. While you will have confidence in your business doing well it is always wise to consider ‘what if’.
If you sign a personal guarantee without checking the terms, the agreement will still be enforceable against you and your personal assets.