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Home > Business Strategy Checklists > Personal Guarantees and the Potential Consequences of Giving Them

Business Strategy Checklists

Personal Guarantees and the Potential Consequences of Giving Them


Checklist Description

This checklist provides an overview of personal guarantees and what the consequences of giving them may be.

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Definition

A personal guarantee is usually given to a bank by a director who is also a shareholder of a company as additional security for the company’s borrowings. Personal guarantees are usually required for start-up companies that do not have a credit record.

A personal guarantee is given for a certain amount plus interest, including any costs and expenses. The amount guaranteed is usually payable on demand. The guarantor cannot terminate the guarantee on his/her own initiative unless he/she is prepared to pay to the bank the whole outstanding amount.

As a company’s finances improve, the bank may be open to canceling the personal guarantee. However, this is not likely to happen unless the bank has equal or greater security from elsewhere. The release of a personal guarantee is done in writing. The guarantor must always insist that the bank gives a written confirmation of the termination; otherwise, he/she may remain liable for the debt.

A guarantor must make sure that they are comfortable with the amount that they guarantee to the bank. If the company defaults on the payment of the loan, the bank will demand payment under the guarantee, and if the guarantor cannot pay the bank can seek a bankruptcy order against the guarantor. The bank can ultimately force the personal guarantor to sell any of his/her assets in order to pay the amount owed.

Personal guarantees are quite commonly required by banks, but they should be given with extreme caution because they can have serious implications for the personal wealth of the guarantor.

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Advantages

  • A personal guarantee allows a company to borrow money without additional encumbrances on its business or assets.

  • If the company keeps up its payments, there is no need for the bank to enforce a personal guarantee.

  • Most banks and reputable financial institutions will insist that the director and/or shareholder giving the personal guarantee obtains independent legal advice in respect of the implications of giving such a guarantee. This will ensure that the signatory to a personal guarantee understands the terms and consequences of giving the guarantee.

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Disadvantages

  • The burden of a personal guarantee stays with the director and/or shareholder who gives it. It does not affect the assets of the company. The bank can therefore demand payment from the person giving the guarantee, rather than from the company.

  • The guarantee is usually given on a full-indemnity basis, which means that to initiate an order for payment the bank will only have to prove that the money is owed and that the loan repayments have not been made.

  • Until the bank recovers the money owed by the company in full the person giving the personal guarantee remains liable in full.

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Action Checklist

  • Before you enter into a personal guarantee, explore other options you might have that would allow the company to borrow money without you being personally liable.

  • Any responsible bank or financial institution will insist that before signing a personal guarantee you receive independent legal advice. This will enable you to understand the implications and consequences of giving a personal guarantee.

  • In general, if you can avoid giving a personal guarantee, do so, because it can have implications for your personal wealth and your family’s future.

  • Usually, a personal guarantee is a continuing security, which means that there is no termination date within the guarantee. You can give the bank written notice to terminate the guarantee, but in doing so you will have to pay the bank the outstanding balance of the loan.

  • If you have to give a personal guarantee, make sure that you know your total liability and that this is within your means.

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Dos and Don’ts

Do

  • Consider carefully the implications of giving a personal guarantee, as it could have a major effect on your personal wealth.

  • Do negotiate with the bank to try and find an alternative security for the loan rather than a personal guarantee, such as a guarantee given by the company.

  • If you give a personal guarantee, make sure that you cap your liability to an amount that you can pay in the event of default by the company.

Don’t

  • Don’t give a personal guarantee without understanding its terms and fully weighing the consequences of giving it.

  • Don’t give the bank written notice to terminate the guarantee if you are not prepared to pay the bank the outstanding debt.

  • Don’t forget that when a bank agrees to release a personal guarantee it must do so in writing. Do not accept anything less than written confirmation from the bank.

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Further reading

Article:

  • Fiore, Nicholas J. “S shareholder’s personal guarantee did not allow for increased basis.” Tax Adviser (January 2001).

Report:

  • Robinson, Kenneth J., and Eugenia D. Short. “Bank deposit guarantees.” Washington, DC: Independent Institute, 1996. Order online at: tinyurl.com/3lo2aet

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