Personal Guarantees and Bank Guarantees: Understanding the Risks
Guarantees are common in commercial transactions. They may be requested when entering a commercial lease, obtaining finance, opening a supplier account, purchasing a business or entering another significant commercial arrangement.
While signing a guarantee can sometimes appear to be a routine part of completing a transaction, the consequences can be significant.
A guarantee is designed to provide another party with additional security if the person or business primarily responsible for an obligation fails to meet it. Depending on the type of guarantee and its terms, this could expose personal assets or affect access to business funds and credit facilities.
Two arrangements commonly encountered in business transactions are personal guarantees and bank guarantees.
Although their names are similar, they operate differently and create different risks.
Before providing either type of guarantee, it is important to understand what is being secured, when the guarantee can be called upon and what your potential financial exposure may be.
What Is a Personal Guarantee?
A personal guarantee is an agreement under which an individual agrees to be responsible for the obligations of another person or entity if those obligations are not met.
In a business context, this commonly occurs where a company enters into an agreement and a director or business owner is asked to personally guarantee the company’s obligations.
For example, a landlord may agree to lease premises to a company but require the company’s directors to personally guarantee the tenant’s obligations under the lease.
Similarly, a supplier providing goods on credit may require a director’s guarantee before establishing a trading account.
The guarantee gives the other party an additional avenue for seeking payment or enforcing certain obligations if the company does not perform as required.
Why Are Personal Guarantees Requested?
Companies are separate legal entities from their directors and shareholders.
One reason people operate businesses through companies is to create separation between the company’s obligations and their personal affairs.
From the perspective of a landlord, lender or supplier, however, dealing with a company can create additional risk.
This can be particularly relevant where the company:
- is newly established;
- has limited assets;
- has a short trading history;
- is entering a substantial long-term agreement;
- is seeking significant credit; or
- has limited financial information available.
A personal guarantee can provide additional security by making an individual personally responsible for specified obligations.
For the guarantor, however, this can significantly change the risk associated with the transaction.
A Company Structure Does Not Necessarily Protect You From a Personal Guarantee
Business owners sometimes assume that operating through a company means their personal assets cannot be exposed to business liabilities.
A company generally has its own legal identity, but personally guaranteeing a company’s obligations can create direct personal exposure.
If the company cannot meet the obligations covered by the guarantee, the party benefiting from the guarantee may seek to enforce it against the guarantor, subject to the terms of the agreement and applicable law.
Depending on the circumstances, this could have serious financial consequences.
For this reason, personal guarantees should not be treated as insignificant administrative documents.
They should be reviewed as part of the overall commercial risk of the transaction.
Where Might You Encounter a Personal Guarantee?
Personal guarantees appear in many types of commercial arrangements.
Common examples include:
- commercial and retail leases;
- business loans;
- equipment finance;
- supplier credit applications;
- trade accounts;
- business purchase arrangements;
- franchise agreements; and
- other significant commercial contracts.
In some cases, the guarantee may appear in a separate document.
In others, it may be contained within a larger agreement or within terms attached to a credit application.
Business owners should therefore carefully review all documents rather than assuming a form is simply administrative.
What Should You Check Before Signing a Personal Guarantee?
The wording of the guarantee determines the obligations being accepted.
Before signing, there are several important matters to consider.
What Obligations Are You Guaranteeing?
Determine exactly what the guarantee covers.
Is it limited to a specific payment, or does it apply to all obligations under the underlying agreement?
A broadly drafted guarantee could potentially cover more than the amount you initially expected.
Is There a Financial Limit?
Check whether your liability is capped at a particular amount.
An unlimited guarantee may expose the guarantor to significantly greater risk than a guarantee with a clearly defined maximum.
How Long Does the Guarantee Continue?
Some guarantees may continue for the duration of a particular agreement, while others may operate on a continuing basis.
You should understand when the guarantee begins and, importantly, when it ends.
Can the Guarantee Cover Future Obligations?
Some guarantees may be drafted to cover future amounts or obligations rather than only liabilities existing when the document is signed.
This can increase the potential exposure over time.
Can the Guarantee Be Enforced Directly?
You should understand whether the beneficiary must first pursue the company or whether it may have rights to pursue the guarantor directly in particular circumstances.
What Happens If You Leave the Business?
If you sell your shares, resign as a director or otherwise leave the business, do not assume your guarantee automatically disappears.
Steps may be required to obtain a formal release.
This can be particularly important when selling a business or exiting a partnership or company.
What Is a Bank Guarantee?
A bank guarantee operates differently from a personal guarantee.
A bank guarantee is generally an undertaking issued by a bank in favour of another party, commonly called the beneficiary.
In a commercial leasing context, for example, a landlord may require the tenant to provide a bank guarantee as security for its obligations under the lease.
The bank agrees to pay the beneficiary up to the amount specified in the guarantee if a valid demand is made in accordance with its terms.
The bank will generally require the customer to provide security or otherwise satisfy the bank’s requirements before issuing the guarantee.
As a result, a bank guarantee can affect the business’s available funds or borrowing capacity.
Bank Guarantees in Commercial Leases
Bank guarantees are commonly used as security under commercial leases.
A landlord may request a guarantee equal to a specified number of months’ rent or another agreed amount.
The guarantee provides the landlord with financial security if the tenant fails to meet certain obligations.
For the tenant, providing a bank guarantee may avoid paying an equivalent amount directly to the landlord as a cash security deposit.
However, this does not mean the guarantee is cost-free.
Depending on the arrangements with the bank, funds may need to be secured or the guarantee may affect the tenant’s available credit facilities.
The bank may also charge fees for issuing and maintaining the guarantee.
These costs should be considered when assessing the overall financial commitment associated with a lease.
What Should You Check in a Bank Guarantee?
Bank guarantees can involve several important issues.
The Amount
Confirm the amount of the guarantee and whether the underlying agreement allows the beneficiary to require that amount to increase.
For example, a commercial lease may require the guarantee to increase as rent increases.
The Expiry Date
Some bank guarantees have an expiry date, while others may continue until formally returned or cancelled.
An open-ended guarantee can remain in place longer than expected if the process for releasing it is not properly managed.
The Beneficiary
The guarantee should correctly identify the party entitled to make a demand.
Errors can create unnecessary complications.
Conditions for Making a Demand
The wording of the guarantee determines the circumstances and procedure under which the bank may make payment to the beneficiary.
These provisions should be considered alongside the underlying commercial agreement.
Release of the Guarantee
Understand when the beneficiary must return or release the guarantee.
For a commercial lease, this may depend on the tenant satisfying all obligations at the end of the lease, including any make-good requirements.
Without a clear process, security can potentially remain tied up after the commercial relationship has ended.
Personal Guarantee vs Bank Guarantee: What’s the Difference?
The key distinction is the party providing the security.
With a personal guarantee, an individual agrees to stand behind the obligations of another party, usually a company.
With a bank guarantee, a bank provides an undertaking to pay the beneficiary in accordance with the terms of the guarantee.
Both provide additional security to the beneficiary, but the risks for the business owner are different.
A personal guarantee can potentially expose the individual’s personal financial position.
A bank guarantee may require cash security or affect the business’s borrowing capacity and available funds.
In some transactions, a party may request both.
Understanding the combined effect is important when assessing the overall risk of the agreement.
Guarantees and Commercial Leases
Guarantees deserve particular attention when negotiating commercial premises.
A lease can run for many years and involve substantial financial commitments.
If directors personally guarantee a company’s obligations, their exposure may extend beyond unpaid rent.
Depending on the terms of the lease and guarantee, other obligations could potentially be relevant, including outgoings, repair obligations, make-good costs or other amounts payable under the agreement.
Before providing a guarantee, the lease and guarantee should therefore be considered together.
Focusing only on the current monthly rent may substantially underestimate the potential financial exposure.
Guarantees When Buying a Business
Guarantees can also become important when buying an existing business.
A purchaser may need to provide guarantees to:
- a landlord;
- suppliers;
- lenders;
- equipment finance providers; or
- other commercial parties.
The buyer should understand these requirements when calculating the amount of capital and security needed to complete the acquisition and operate the business.
If existing contracts are being assigned, new guarantees may also be required as a condition of consent.
These requirements should ideally be identified during due diligence rather than shortly before settlement.
Guarantees When Selling a Business
For sellers, existing guarantees can create a different problem.
Selling the business does not necessarily mean every personal guarantee associated with it automatically ends.
A former owner could potentially remain exposed under a guarantee unless they are properly released.
When selling a business, identify any guarantees provided in connection with:
- the commercial lease;
- supplier accounts;
- finance arrangements;
- equipment;
- utilities; and
- other business contracts.
Where appropriate, obtaining releases should form part of the transaction and settlement process.
Do not simply assume the purchaser taking over an agreement automatically releases the previous guarantor.
Can You Negotiate a Personal Guarantee?
A request for a personal guarantee does not necessarily mean every proposed term must be accepted without discussion.
Whether a guarantee can be negotiated will depend on the transaction and the bargaining position of the parties.
Possible matters for negotiation might include:
- limiting the maximum amount;
- limiting the duration;
- restricting the obligations covered;
- providing alternative security;
- reducing the number of guarantors; or
- establishing circumstances in which the guarantee will be released.
For example, a landlord may initially request an unlimited guarantee for the entire lease term, but there may be scope in some transactions to negotiate alternative security arrangements.
There is no guarantee that the other party will agree to changes, but understanding the proposed exposure allows you to make an informed decision about whether to negotiate or proceed.
Don’t Assume a Guarantee Is Just a Formality
One of the biggest risks associated with guarantees is treating them as routine paperwork.
The underlying transaction may be positive and the business may fully expect to meet its obligations.
However, guarantees are designed for circumstances where things do not go according to plan.
Economic conditions can change. Businesses can lose important customers. Partnerships can break down. Unexpected costs can arise. A business that appears financially secure when a guarantee is signed may be in a very different position several years later.
The relevant question is therefore not simply whether you expect the business to perform.
You should also understand what could happen if it does not.
Consider the Worst-Case Scenario
Before signing a guarantee, consider the potential consequences if the underlying business cannot meet its obligations.
Ask questions such as:
- What is the maximum amount I could potentially owe?
- Is that amount capped?
- How long could the guarantee remain in place?
- What assets or funds could be exposed?
- Are there multiple guarantors?
- Can I obtain a release if I leave the business?
- Does the guarantee cover future obligations?
- Are there other security arrangements as well?
- Could the exposure increase over time?
Considering these questions does not mean assuming the transaction will fail.
It means understanding the risk before accepting it.
Keep Records of Guarantees Your Business Has Provided
As a business grows, guarantees can accumulate.
A director may have signed guarantees for a lease, equipment finance and several supplier accounts over many years.
Maintaining a record of these arrangements can make it easier to understand your overall exposure.
Consider recording:
- who received the guarantee;
- what agreement it relates to;
- the maximum exposure, if any;
- when it was signed;
- when it expires;
- how it can be released; and
- whether the underlying agreement remains active.
This can be particularly valuable when restructuring, selling the business or changing directors.
Why Legal Advice Before Providing a Guarantee Matters
The consequences of a guarantee may extend well beyond the immediate transaction.
Before signing, it is important to understand the document itself and the underlying agreement it supports.
A commercial lawyer can help identify matters such as:
- the obligations covered by the guarantee;
- whether liability is limited or potentially open-ended;
- the duration of the guarantee;
- circumstances in which it can be enforced;
- how it interacts with the main agreement;
- release provisions;
- potential areas for negotiation; and
- other security arrangements associated with the transaction.
The objective is not necessarily to avoid every guarantee.
Guarantees are a normal feature of many commercial transactions.
The objective is to understand the risk you are accepting and make an informed decision about whether the proposed arrangement is appropriate.
Personal and Bank Guarantee Advice in Busselton
Personal guarantees and bank guarantees can arise in commercial leases, business purchases, finance arrangements, supplier agreements and many other business transactions.
Because the consequences can be significant, these documents should be carefully considered before they are signed.
At Leeuwin Legal Collective, we provide clear, practical commercial legal advice to businesses and business owners in Busselton and across the South West.
We can assist with reviewing commercial agreements, personal guarantees, bank guarantee requirements, commercial leases, business sale agreements and other contractual arrangements.
We regularly assist clients in Busselton, Dunsborough, Vasse, Yallingup, Margaret River and surrounding South West communities.
Our focus is on explaining your obligations clearly, identifying potential risks and helping you make informed commercial decisions with confidence.
Speak With a Commercial Lawyer in Busselton
If you’ve been asked to provide a personal guarantee or bank guarantee as part of a commercial transaction, make sure you understand the potential consequences before signing.
Leeuwin Legal Collective can review the proposed guarantee and underlying agreement, explain your obligations in plain language and advise you on matters that may warrant further consideration or negotiation.
Book a free 15-minute consultation with our team today.
(08) 6716 9348
Clear advice. Practical solutions. Confidence for your business.
