A personal guarantee is a legally binding obligation on an individual to repay a third party's debt or borrowing. Effectively, if a company or primary debtor does not pay or is unable to pay a debt, then a creditor, for example a lender will become entitled to pursue an individual guarantor for repayment of the debt through the courts. This could even lead to personal insolvency if the guarantor is unable to pay.
Personal guarantees are a common feature of many financial products including business, loans, overdraft, and credit cards. The most common is a director's guarantee whereby a director of a limited company will personally guarantee the repayment of a loan made to his or her company.
Given the personal ramifications on signing a personal guarantee, it therefore cannot be emphasised enough just how important it is for an individual to fully understand the personal financial implications of signing a personal guarantee before agreeing to do so. In particular, a person individual must be made aware of the potential risks and consequences to their personal assets when a primary contracting party (over whom they may have no direct control) defaults on a loan which they have ultimately personally guaranteed the re-payment of.
When might a personal guarantee be unenforceable?
With such draconian sanctions on a personal guarantor for the repayment of a third party's debt, one might question whether there is any defence or legal mechanism available to get out of one's strict guarantee obligation. In essence, the answer, as is often the case is: 'it depends'.
Firstly the courts, who are tasked with entering judgment against a guarantor to repay a defaulted debt, will look at the period of time which has passed since the guarantor's legal obligation to repay the borrowing took effect. A lender has 6 years (or 12 years if the personal guarantee is contained in a deed) within which to bring any legal action, after which they become statute barred from doing so.
Secondly, if a guarantor can evidence that the guarantee was entered into due to a fraudulent or negligent representation, the courts may find that the personal guarantee is void and unenforceable. This is one potential defence that might be available to the guarantor, depending on the circumstances.
Furthermore, if the lender has repudiated the contract to which the guarantee is subject and the guarantor accepts that repudiation then the person who has guaranteed the debt will no longer be responsible for it given that the primary contract to which the debt was owed is then treated as having been terminated and effectively no longer exists.
Similarly, where a lender has acted in such a way that it would be unconscionable for it to then rely on a personal guarantee (such as the lender seeking to reassure a guarantor that the personal guarantee would never be called upon), the courts may determine that the lender is estopped from relying on their rights under the guarantee, because to allow such a right would be inequitable in the circumstances.
It may also be possible that the personal guarantee is waived by agreement between the parties – though very unlikely, given that a lender will seek to pursue repayment of its debt using any and all methods available to it, especially within the financial services sector where parties are entering into agreements for financial transactions at arm's length and have no relationship to each other, other than the financial transaction in question.
In essence, the ability to avoid repayment of a debt under a personal guarantee is usually extremely difficult once a debt falls due and the individual guarantor is called upon. It is therefore crucial for an individual to be well informed and seek advice in the event that they are being asked to sign an agreement which compels them to repay a debt if a company or primary debtor fails to pay it. Otherwise, the consequences to that individual could be dire.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.