Beware the Personal Guarantee

Posted by Luke Mitchell on 21 March 2018
Beware the Personal Guarantee

Significant effort, time and money can be spent in putting in place an ownership structure that maximises the protection of the personal assets of the owners of the business.

However that effort, time and money can be rendered a complete waste if great care is not taking when business owners personally guarantee business liabilities.

Ideally a business owner would never agree to personally guarantee business liabilities. The whole idea of setting up an appropriate ownership structure is to keep personal assets out of the mix. In reality, personal guarantees are often unavoidable where a business needs to borrow funds and/or acquire goods and services on credit.

The key then in not to never provide a personal guarantee, but to carefully consider whether what is being secured by the personal guarantee is critical to the needs of the business and to keep track of how many personal guarantees have been given and to whom they have been given.

Unfortunately we have seen situations where through, a combination of a lack of appreciation of the problems that can be caused through providing personal guarantees and a failure to keep track of how many personal guarantees have been given, a failure of a business has led to personal insolvency and the loss of the family home.

In one particular matter, a client provided a personal guarantee is to each trade supplier to the company through which he operated his business. He had also secured a business loan against the family home. The individual in question did not read the terms of the various personal guarantees (which were attached to supplier credit applications) and did not obtain legal advice before signing the personal guarantees. As a result, he did not appreciate that as a consequence of the terms of the personal guarantees, he was providing the suppliers with a charge over all of his personal property. In practical terms, this meant that all of the relevant suppliers registered caveats on the family home.

The business subsequently ended up in dispute with its major supplier, who stopped supplying goods to the business. The slowdown in trade that this caused had the knock on effect of drying up cash flow so that the business fell behind with its other suppliers. Ultimately, the company behind the business was forced into liquidation.

In order to pay down business loan that had been secured against the family home, the business owner put the family home on the market and exchanged contracts with a buyer. He did not realise that the various suppliers had lodged caveats on the title of the family home which, unless removed, would prevent the completion of sale.

Ultimately, we were able to assist the business owner in negotiating an agreement with the various suppliers that saw them receive a partial payment of the debts that had been personally guaranteed by the business owner in return for those parties withdrawing their respective caveats. While this meant that the sale of the family home went through, given the substantial outstanding balance of the debts owed to the various suppliers, the business owner was left with no other choice but to enter into voluntary bankruptcy.

Had the business owner sought advice prior to providing personal guarantees to these multiple parties he would have been aware of the significant risks that he was exposing himself to personally. Not only would he have received advice as to the potential of a caveat being lodged on his family home, he may have also appreciated the "house of cards" situation that he had placed himself in by providing multiple personal guarantees.

We specialise in providing clarity and confidence to business operators in their legal relationships – contact us today to discuss the legal needs of your business.