Personal Guarantees are used as a way of overcoming concerns regarding future events, but it is never something to be taken lightly. It is important that a person providing a personal guarantee understands its full implications before agreeing to it. Obtaining independent legal advice should always be recommended.
What is a personal guarantee?
A personal guarantee is an individual’s legal promise to ensure that a person or entity will perform a contractual obligation to a third party. If that person or entity fails to perform the contractual obligation, the individual providing the guarantee must step in and perform the obligation.
Some common examples of situations where personal guarantees are required are:
- A company entering into a lease as a tenant;
- A company obtaining funding from a third party;
- A company supplying products to another company prior to payment being received.
A recent case study from the High Court
In a matter before the High Court, one of three directors of a company [Company A] signed a personal guarantee to a supplier company [Company Z], personally requesting Company Z supply Company A with orders it required and in consideration of that supply, he [Mr M from Company A] personally undertook to pay the amount payable upon demand.
Five years after entering into the agreement, Company A fell behind with payments. Company Z sought payment from Company A. In that correspondence, Company Z mentioned Mr M’s guarantee.
A payment plan was arranged, but within the year Company A had fallen behind with its payments.
Another payment plan was arranged, but Company Z advised that it would pursue Mr M personally if the payments were not met. At that time, the outstanding amount was approximately $160,000.
One month later, Mr M resigned as a director of Company A. At this point the outstanding amount was nearly $170,000.
Shortly after Mr M’s resignation, one of the directors from Company Z visited him to check on his well-being. Mr M explained that he had resigned because to have remained with Company A would have been detrimental to its ability to reduce debt and he did not now consider he was responsible for debt going forward. Company Z’s director [Mr F] apparently said something along the lines of “Not to worry about it”.
The second payment plan did not assist and within another two months the outstanding debt was approximately $270,000.
At this point, Company Z lost patience. It sent a letter of demand to Mr M under the guarantee requesting payment of approximately $270,000 within 7 days.
Mr M responded explaining that he was no longer a director or an employee of Company A. Not surprisingly, Company Z responded by pointing out the fact that this did not hinder it from calling on the personal guarantee.
Shortly thereafter, Company A was placed into liquidation. Company Z pursued its claim against Mr M.
Mr M argued that he had been naive in signing the agreement and if he had been aware it was made in his personal capacity, and not on behalf of Company A, he would never have signed it. He also argued that one of the other directors of the Company had directed him to sign it.
Mr M also suggested that he had received a partial release from the guarantee from Company Z’s Mr F on the basis that when he had explained to Mr F that he was not going to stay with the Company so as not to be detrimental to repayment of debt going forward, Mr F said “not to worry about it”.
The Court said that the law was clear and if obligations guaranteed are not satisfied, the guarantor must satisfy them to the extent of the terms of the guarantee. It said however that a continuing guarantee, such as the one in this transaction, could be released or revoked in respect of liability to accrue in the future.
The court agreed that a release from such a guarantee can be effective orally, although also noted written notice was wise.
However, it considered that in this case the proposition that the guarantee was released or varied by Mr F was not supported by the evidence as:
a) Mr F was adamant that the words “don’t worry about it” did not relate to the guarantee;
b) There was no contemporaneous documentation to suggest Mr F had released the guarantee; and
c) Mr M did not mention the release when it responded to Company Z’s demand on the guarantee.
The Court concluded that Mr M was liable under the personal guarantee for the $270,000.
Further, the fact that Mr M had resigned from the Company did not release him or act as a partial release from the guarantee.
Personal guarantees can come in many shapes and sizes. It is important to ensure you and receive adequate legal advice on contracts, and particularly on the potential impact of any personal guarantees included in those contracts.
By Shyrelle Mitchell, Partner, Heaney & Partners
This article featured in NAI Harcourts' Key Assets magazine issue 3, 2019.
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