A guarantee is a promise to pay a third parties’ debt. A typical example is where a director guarantees a company.
We all know that personal guarantees should be avoided at all costs. However, if you are in business, it is inevitable that at some point you will need to give a personal guarantee. Typically, it will be a trade guarantee, a lease guarantee, or a guarantee of a loan.
In this article we look at common clauses and traps which you should be aware of when agreeing to sign a guarantee.
The following points are not hypothetical they are all based on real-life situations we have seen.
Charging clauses- The number one trap to avoid:
Some guarantees go beyond making you personally liable. They try and create a security over all your assets. It is not unusual for a personal guarantee to include a charging clause. Charging clauses are often found in trade guarantees and sometimes in lease guarantees. An example of a charging clause in a personal guarantee is:
I agree to charge all my interest in any land I currently hold to better secure the performance of my obligations as guarantor, and I consent to a caveat being lodged on my interest in the title to any land so held by me.
A charging clause like this allows the trade supplier to register a caveat over any property you have an interest in. This limits your ability to deal with that property without obtaining the consent of the trade supplier. It may even trigger a default under a mortgage you have on that property. You should always insist on a charging clause being deleted from the guarantee.
Capping the liability
Unless a guarantee is capped the potential liability of a guarantor is unlimited. Best practice is to always insist on the maximum liability under the guarantee being capped at a dollar amount. For example, if a trade guarantee is being given you would always want to cap the maximum liability at the trade credit limit when the guarantee was initially signed. That way if the supplier extends the credit limit of the customer either consciously or unconsciously through poor credit management the guarantor will not be exposed to the increased credit limit.
Insist on an expiry date
Without an expiry date the liability of a guarantor is indefinite. By including an expiry date, it gives the guarantor certainty as to how long the guarantee will run for and also gives the opportunity to reassess the guarantee at a point in the future.
Does the guarantee include an interest rate?
Often a guarantee will include a clause that allows interest to be charged to the guarantor if money becomes owing under the guarantee. Whilst charging interest is not unreasonable what can be unreasonable is the interest rate charged. It is not uncommon for guarantees to have interest rates as high as 15% to 18%. The interest rate should always be renegotiated to a commercially realistic rate. In the current economic climate 5% to 7% is more realistic.
Get released from the Guarantee if you are no longer involved with the business
In most cases a guarantee is given because you are involved with the business and there is a commercial advantage to you and the business. But what happens if you are no longer involved with the business? In that case you should request to be released from the guarantee. We have seen big problems occur where a director has given a guarantee and subsequently left the business without arranging a release of the guarantee. The problem being that the guarantor is still liable even years later.
Conclusion
Often the terms of guarantees can be negotiated.Carefully read a guarantee before signing and if in doubt get advice.
If you need advice about your business or whether you should sign a guarantee, we can help. We are experts on the legal implications of guarantees. Simply contact Lord Commercial Lawyers on (03) 9600 0162 or email us at: info@lordlaw.com.au or fill out the form on this page.
About us
Lord Commercial Lawyers is a commercial law firm based in the Melbourne CBD. We work with businesses and individuals to help them achieve their legal and commercial goals.
