Personal guarantees: always read before you sign

This article was co-authored by Abbi Hague, Legal Apprentice, Manchester office.

Personal guarantees can be crucial for businesses, allowing them to expand and improve cash flow where they otherwise would not be able to. 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.

A personal guarantee is used to ensure that a guarantor party fulfils an obligation (whether this be monitory or performance) if the guaranteed party fails to do so. This is often used by SMEs to secure loans against directors where personal guarantors legally promise to repay credit issued to a business. Often such businesses will only obtain credit from banks, landlords and even suppliers if its obligations are backed up by such a guarantee.

Some personal guarantees are obvious on the face of them and recommend that the person signing them takes independent advice. Legitimate guarantees require the guarantor to honour the contract and repay debts in the event that the business fails to do so. Many personal guarantors never have to cover such debts, but the risk is always there.

The majority of guarantees remain valid for years and in some cases cannot be terminated. Most guarantees do however include a clause allowing the guarantor to terminate the guarantee by giving notice. Some clauses 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.

A guarantor is liable until the primary debtor is released from the debt, which usually means the debt has been repaid in full. Guarantors may be able to take out insurance to help cover the monies they may be required to pay if the guarantee is “called in”. However, insurers will not cover all costs and therefore guarantors may still be at a loss.

More recently, we have noticed personal guarantees have been incorporated into agreements through more discreet clauses, particularly in supply and trade agreements. Some individuals are signing such contracts without completely understanding them or even reading what they are agreeing to. It is often the case that when business owners and individuals read long, legal documents, key clauses are overlooked and the legal language and term implications are not properly understood. As a result, the individual may assume personal responsibility without releasing it.

In order to protect against agreeing to unclear guarantees and being liable for debts, there are a number of clauses and procedures in place that should be considered:

  • The statute of frauds applies to personal guarantees which requires the contract to be in writing and signed by the parties bound by the contract. This is used to prevent fraud and encourage people to read the contract that they are required to sign.
  • All monies guarantees will cover all amounts which the debtor owes to the creditor under any arrangements (including future arrangements), regardless of how they arise. This means the guarantor has agreed to enter into the guarantee for the purpose of repaying all outstanding debts.
  • The “purview doctrine” offers protection to guarantors with amended contracts. If the principle contract agreed by a guarantor is amended to the extent that it no longer falls under the purview of the guarantee as originally drafted, then the guarantor may no longer be bound. This even offers protection to those who have consented to the changes – the doctrine may intervene to ensure that the amended contract is regarded as entirely new, this is subject to the amendments made. Anti-discharge provisions may, however, prevent the doctrine from taking effect.

In addition to the above, it is recommended that to limit the cost and damage guarantors may suffer, that guarantors negotiate a cap on the percentage of personal assets that can be seized. Lenders may attempt to collect such assets, as guarantors are personally liable.

Unfortunately, we have seen an increased number of cases where deceit has played a part in obtaining the personal guarantee. Businesses sometimes mislead guarantors to ensure they can secure loans. Unfortunately the recent restrictions implemented following the Coronavirus outbreak have resulted in insolvency and bankruptcy becoming more pressing concerns for a number of businesses. Personal guarantors may be left footing the bill for these businesses outstanding costs and liabilities.

In the prevailing economic climate, more businesses are struggling to remain afloat, which will “shine a light on” a number of problems. Personal guarantees that were agreed with assurances that they would “never be called upon” will have been affected by the pandemic and may no longer be in the same financially secure position, forcing them into insolvency. Businesses convincing guarantors of a diminished risk are often equally as likely to become insolvent.

Despite misleading guarantors into signing an agreement being common, such agreements may be void if misrepresentation is determined. The contract is not binding if there is:

  • A misrepresentation as to the state of indebtedness between the bank and the company at the time the guarantee was given.
  • A misrepresentation as to what was being guaranteed.

For individuals, if you are asked to sign a personal guarantee you should always consider taking independent legal advice and consider what the terms mean and how it may impact you, your finances and your family. Always read the small print as if you sign a personal guarantee without checking the terms, the agreement is still enforceable against you and your personal assets.

Related item: Service of foreign process on Bermuda resident persons and entities under the Hague Convention

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