EXACTLY WHAT ARE YOU RISKING BY GIVING A GUARANTEE AND INDEMNITY?

EXACTLY WHAT ARE YOU RISKING BY GIVING A GUARANTEE AND INDEMNITY?

It is an unavoidable feature of modern commercial life that, as a business owner or a director, you are required to provide personal guarantees on behalf of your business and/or company, particularly to suppliers providing goods on credit and to financiers advancing funds.

A guarantee is the promise by one party (generally the owner or director) (the guarantor) to perform the obligations of another party (generally the obligation of a business or company to pay money) (the principal) to a third party (usually a supplier or a financier) (the third party) in the event that the principal is unable to perform its contractual obligations.

A guarantee itself forms a secondary obligation, with the guarantor’s liability dependent on the liability of the principal being established. If, for any reason the principal’s liability to perform the guaranteed contractual obligations is discharged, then the guarantor’s obligations are discharged.

For this reason, most modern guarantees have been expanded to include indemnities, creating the guarantee and indemnity most commonly utilised today. 

On signing a guarantee and indemnity the guarantor becomes principally (or primarily) liable for the debts of the principal, or, put another way, agrees to stand in the shoes of the principal and to personally perform the principal’s obligations to the third party.

For the purposes of this article, a “guarantee” should be read as a “guarantee and indemnity”.

It is essential to obtain legal advice prior to signing a guarantee, even if you regularly sign these documents, as the terms vary from guarantee to guarantee.

For example:

  1. a guarantee may be limited to one transaction or may be a continuing guarantee; that is, guaranteeing further obligations incurred by the principal and continuing in operation until formally discharged by the third party.
  2. your obligation may be sole, it may be joint with other guarantors (known as co-sureties) or joint and several with the co-sureties. Where your obligation is joint and several, the third party can select which of you to pursue for performance, it is not obliged to take collective action against the co-sureties.
  3. may indicate an obligation to pay a fixed amount or may extend to any amount owed by the Principal.

A solicitor can assist you by drawing any serious pitfalls to your attention and assist you with negotiating better terms for the guarantee, such as limiting the operation of the guarantee or making provision for its release on occurrence of certain events.

While it is common that personal guarantees are now secured by a mortgage over real property in favour of the third party, the absence of security does not prevent your assets from being made available to the third party.

By being a personal guarantor, any asset that you hold personally, or which you have an entitlement to receive (such as distributions from a trust) is at risk. In the event that you are unable to perform your guaranteed obligations, the third party may seek judgment from a Court for any amounts owing to it.

If successful, the third party will be entitled to utilise all methods of enforcement available to it by law to receive performance. Enforcement options vary according to circumstance, but include a warrant on title to sell any real property or, if there are insufficient assets, issuing of a of bankruptcy notice, and if not complied with, a creditor’s petition.

Providing a guarantee may also affect your personal capacity to borrow as it is a present liability even if it has yet to be called upon (and may never be).

These significant risks make it prudent to:

  1. Obtain legal advice as to nature and effect of the guarantee should you be asked to provide a guarantee.
  2. Obtain advice from your financial advisor as to your ability to meet your obligations should you be required to perform your obligations as guarantor and to ensure your assets are appropriately structured to minimise exposure. You should also consider how the guarantee may affect your future personal financial plans.
  3. Keep yourself appraised of the principal’s liabilities to the third party and, at the earliest possible time, seek a release from your obligations as guarantor.

JHK Legal is able to assist with advising on guarantees when faced with one to sign, work closely with your financial advisor to ensure your legal as well as financial needs are met and also to assist with the release process. All information in this article is written by way of general comment and any reader wishing to act on information contained in this article should first approach their legal professional advisors for properly considered professional advice which takes into account the reader’s specific situation.

If you would like to discuss any part of the above, please contact JHK Legal on 07 3859 4500 or [email protected]

Belinda Pinnow – Senior Associate

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