Guarantees can be risky business

As the great George Costanza said on a classic episode of ‘Seinfeld’ ‘everybody knows you’ve got to keep your worlds apart’. But, worlds can collide for a director. A director who gives a personal guarantee in respect of a company’s obligations can be personally liable for those obligations if the company fails to perform them.

Creditors, including banks and other lenders, may enforce a director’s undertakings by applying to court for an order to satisfy the company’s debts. This may include an order to seize the director’s personal assets (such as their family home).

When 2 worlds collide

The ‘separate legal entity’ principle generally provides for a company’s directors and shareholders to be protected against the company’s liabilities. But, Costanza should be reminded that directors who provide personal guarantees are not protected by this safeguard. Accordingly, a director places its personal assets at risk when giving a guarantee. Worlds colliding.

The following 4 factors have been prepared for Costanza. In fact, they should be carefully considered by directors before providing a personal guarantee.

1. Clarity

There are several types of guarantees that a director may choose to provide, including:

limited guarantee – where a director agrees to be liable for a specific debt or obligation of the company;
joint and several guarantee – where multiple guaranteeing directors become liable for a specific debt or obligation of the company on a ‘any or all’ basis, irrespective of their individual contributions;
continuing guarantee – where a director continues to be liable for any past, present and future debts or obligations owed by the company, even after the initial debt or obligation has been honoured; and
‘all moneys’ guarantee – where a director is liable for all debts and obligations of the company.

2. Resignation

Director’s guarantees are typically ‘personal’ in nature. As such, the sale of the business or a director’s resignation from the company may not necessarily relieve the director of his or her obligations under the guarantee, unless of course a release is obtained.

3. Keep track

A copy of all personal undertakings and guarantees by a director should always be safely kept. It is recommended that a register of guarantees be kept and updated frequently, especially where a director guarantees or foresees guaranteeing multiple undertakings.

4. Independent advice

Guarantees are serious undertakings and are often an unavoidable part of doing business for company directors. Where a lender, for example, requires a director to guarantee a loan to the company, it is important to fully understand the consequences of the terms being accepted.

In addition to financial advice, directors should also seek independent legal advice on the guarantee’s implications and to assist with minimising potential personal liability.

The collision of worlds once threatened to kill ‘independent George Costanza’. Likewise, ill-thought out personal guarantees can have unexpected and devastating consequences on individual directors when such guarantees are provided without the requisite understanding and consideration. Indeed, what can often be framed as a mere formality in the hustle and bustle of complex transactions is in reality nothing of the sort.

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