The dangers of director’s guarantees

It is common for directors of companies to be required to provide a director’s or personal guarantee to guarantee the performance of a company’s obligations under contracts entered into by the company.

In the absence of a personal guarantee, a director of a company is only personally liable for debts of the company and claims against the company where the director is in breach of theirs duties as a director.

Third parties such as banks, landlords and suppliers will often require directors to personally guarantee that the company will repay its debts and comply with its obligations under contracts entered into. Where personal guarantees are provided, the third party can personally pursue the guarantor director. Directors therefore need to be careful when negotiating and providing personal guarantees and should consider the extent of their exposure, whether that exposure may be limited and what rights they may have against the third party seeking the guarantee and any co-guarantors.

Some common issues which directors need to consider include:

1. Guarantee continuing

Most guarantees are not limited in time. This means that the guarantor is liable for any past, present and future obligations owed by the company. Even once the initial debt for which the guarantee was provided is repaid, the director may still be liable for any subsequent indebtedness between the company and the third party.

2. Joint and several liability

Many companies have two or more directors. Guarantees are usually sought from all of the directors of the company and they are typically liable jointly and severally for the debt of the company to the third party. This means that the third party is able to recover against either one or all of the guarantors, in the third party’s absolute discretion, any amounts owing to the third party by the company. This right applies even before the third party has exhausted all attempts to seek recovery against the company. Usually the third party will focus its recovery attempts on whichever guarantor it believes has the best capacity to pay, or has personal assets which can be utilised to achieve the quickest result.

3. Director’s guarantees do not cease when directorship ceases

A person’s resignation as a director does not mean that any guarantee that was previously provided by that person in their capacity as a director, ceases. Therefore, if a person is resigning as a director of a company, it is essential that the person seek a signed release of their obligations as guarantor from any creditor and co-guarantor.

4. Guarantees may be limited or unlimited

Guarantees are either limited to the extent identified in the guarantee document, or they may be an ‘all monies guarantee’ that is, the guarantor’s potential liability is unlimited and covers all money due by the company to the third party.

5. Rights against the company and co-guarantors

If one guarantor is pursued by a third party, that guarantor can make a claim against any co-guarantors or the company whose debt it guaranteed. A guarantor is able to make a claim against co-guarantors seeking that they pay their equal share of the debt which the guarantor has been ordered to pay. However, the main risk associated with this course of action is whether the company or the co-guarantors have the assets available to provide the required contribution. Further, such action would typically involve the guarantor initiating Court proceedings.

It is therefore imperative that directors be aware of their obligations prior to entering into guarantees and steps are taken, where available, to minimise any potential exposure.

Directors should also consider:

Directors should also consider asset protection strategies when acquiring personal assets. For example, where a director acquires personal assets, consideration should be given as to whether these assets should be put in the director’s name or, for example, their spouse’s name. On occasions it may be necessary when acquiring personal assets, in order to satisfy a lender’s requirements, for there to be a minimal proportion of asset ownership held by the director. In many instances, for example when a director is buying their own home with their spouse, in order for the lender to advance the money to assist in the purchase of the property, they may require the director to have at least a minimal holding in the property (for example, 1%). There are various asset management strategies, some of which may be employed at a relatively low cost, others however may involve significant cost and it may be more appropriate to consider such strategies at particular points in time, for example, when the home is being sold and a new home is being bought.

Solari & Stock’s Commercial & Property Team can provide advice and assistance in relation to director’s responsibilities and strategies for minimising the risk of personal assets being exposed.