10 – giving guarantees – are you giving away more than you think?
It is commonplace in business for guarantees to be requested – if your business signs up as a customer for terms of trade, unless you are a sole trader, a guarantee will often be requested from the company directors.
Directors will always be asked to give personal guarantees on bank loans, and for some lenders it is the standard practice to require shareholders to give a personal guarantee. Related companies will regularly be required to give guarantees, as will trustees of trusts.
Typically, the guarantee that will be required will be an “all obligations” guarantee – and it could be that you as the guarantor have signed up for more than you bargained for.
Three common scenarios are below:
Andrew, Lila and Dougal are the directors of A Limited, one of a group of related companies. Andrew, Lila and Dougal are required by the bank to personally guarantee the obligations of A Limited, and so give an all obligations guarantee.
Lila and Dougal are directors of B Limited, which uses the same bank as A Limited. A Limited and B Limited have shareholders in common and although they are not “related” companies they have close connections in the way that they work together, and so the bank requires A Limited to guarantee the obligations of B Limited.
Andrew has not been asked directly to personally guarantee the obligations of B Limited, although its directors have done so.
B Limited defaults on the loans it has with the bank, and does not have enough assets to repay what is owing to the bank. The bank calls on all the guarantors of B Limited, including A Limited. It also calls upon Andrew, pursuant to the guarantee he gave in relation to all of the obligations of A Limited.
One Limited is the tenant under a long term lease – an initial term of 15 years, plus two further rights of renewal of 10 years each. As the director of One Limited, Tilly has given a guarantee of the company’s obligations and liabilities under the lease to the landlord.
Five years into the initial term of the lease, One Limited sells its business to Two Limited, and Two Limited takes over the lease. The landlord won’t agree to release Tilly from her guarantee, although it takes further guarantees from the director of Two Limited. In 3 years the business is sold again to Three Limited, and then 3 years later it sold to Four Limited. Two years later Four Limited defaults on its obligations under the lease. Four Limited goes into liquidation and the guarantor declares bankruptcy. Tilly, on the other hand, has been very successful since selling the business.
The landlord is determined to recover its costs, and so takes the steps that are open to it in pursuing all the guarantors under the lease, including Tilly. As the most successful of all the guarantors. Tilly bears the brunt of the costs owing to the landlord even though it has been many years since she has had anything to do with the lease, and she knows nothing about any of the businesses who occupier the premises other than Two Limited.
Harvey and Freda have asked their friend Maurice to be a trustee of their trust. As Maurice doesn’t benefit from the trust, he is an independent trustee.
Harvey and Freda borrow some money in their personal names to set up a business venture, and the trust is asked to give a guarantee of their liability. Maurice has heard that independent trustees are not personally liable for a trust’s obligations, and assumes that this is the “default” legal position (ie that’s just how it is and he doesn’t have to take any further steps to protect himself).
Harvey and Freda’s business fails, and the trust does not have sufficient clear assets to repay what is owing to the bank. Along with Harvey and Freda, the bank calls on Maurice, pursuant to his guarantee as a trustee of the trust, to make up the shortfall.
Can the banks and the landlord do what they have done?
Yes. In all of these instances, the banks and the landlord, as beneficiaries of the guarantees, are entitled to do what they have done.
The first, and most important, point to remember with an all obligations guarantee is that it is exactly what it claims to be: a guarantee of all of the obligations of the entity that you are giving a guarantee for, even if you are not aware that those obligations exist, or even if you have ceased to have anything to do with the entity for which you gave a guarantee.
The beneficiaries of a guarantee will not always let you know if you have incurred new obligations (ie a bank might not tell a guarantor if the principal has borrowed more money).
Guarantees typically remain in place until they are released in writing. Even there then may be a “claw back” period of up to two years.
With trusts, trustees have personal liability (even independent trustees) unless it is explicitly stated in documentation that the guarantee is limited to the assets of the trust, and that the independent trustee is to have no personal liability.
What can I do to protect myself?
Whenever possible, do not give a guarantee.
If you have to give a guarantee, limit it to a monetary amount, a time period or a particular entity, or negotiate to have it automatically released on the happening of a certain event.
Ask a landlord if a guarantee of a lease could be replaced by a different security, for example a bank guarantee.
Ask for indemnities from your fellow guarantors, to try and determine as between you who is liable for what amount under the guarantee.
Ask for guarantees to be released as soon as possible once the position of the principal improves, and the principal has more assets for the bank to rely on as security.
Ask for guarantees to be released as a matter of course when having mortgages and other securities discharged.
Request in writing that banks and landlords advise you when the principal’s position changes, such that your exposure under the guarantee is increased. Follow up with banks and landlords in this regard on a regular basis.
Disclaimer: The content of these articles are general in nature and not intended as a substitute for specific professional advice on any matter and should not be relied upon for that purpose.