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The trouble with personal guarantees – a trap for the unwary

Problems in giving a personal guarantee

The Banking Royal Commission has highlighted problems that can arise if a person acts as guarantor for another person. By signing a guarantee, you are promising a creditor or lending institution you will pay another borrower’s debt if they cannot pay it. You can become the guarantor for the debt of another person or a company.

Why do lenders want a personal guarantee?

Why does a lender ask for a personal guarantee from another person? Because there is doubt that the original borrower can repay the loan because of insufficient assets, insufficient income or a bad credit rating. You could be putting your assets at risk to guarantee a person who the lender, based on its experience, considers a doubtful prospect.

Main problem with personal guarantee

The main problem with guarantees is that the guarantor often believes that they might never have to put up any money. Often the borrower will say it’s just a formality or a piece of paper the bank wants signed. Whatever it’s called, you are promising to pay if the borrower doesn’t.

Why give a personal guarantee?

Some guarantees are made for good reasons. Parents may help their children when they are just starting work, with no credit rating, if the lender won’t give them a loan. You wouldn’t be giving the guarantee if you didn’t trust your child, and the liability is usually limited.

Limits on guarantees

Suppliers and other creditors ask for personal guarantees if you’re running a business through a company or a trust. There’s not much you can do about this but, if the business you operate is risky, make sure your spouse is not a guarantor, and that your main assets are not in your name. Remember, some guarantees are worse than they appear. Continuing guarantees stay in force until they are cancelled by mutual consent of the lender and guarantor. Make sure any guarantees you give have a time limit, and also a limit on the liability.

Joint and several guarantees

Joint and several guarantees are used when more than one person goes guarantor on the same loan. The words “joint and several” mean that each of the guarantors is jointly and individually liable for the whole debt. If the bank takes action against the guarantors it will usually sue the one with the most assets, and leave them to sue the co-guarantors for reimbursement.

Partnerships and guarantees

Partnerships can also cause problems because you do not have to sign a guarantee document to be liable. Legally all members of a partnership are jointly and severally liable for the partnership debts. If you go into partnership with people of limited means, you could find yourself liable for all the partnership debts because your partners cannot pay. That’s the same as being a guarantor for all the other members of the partnership.

Finally, get advice before entering into a personal guarantee

Thousands of people have been bankrupted because of signing guarantees, but this is easily avoided. You only have to refuse to sign, or if it is a close family member, make sure that you are sure of the extent of your liability. Even better, seek legal advice first.

Disclaimer

This article was written by Margaret Miller, partner at Bell Legal Group. It is general in nature, is not legal advice and must not be relied on as such. If you need assistance with a personal guarantee, please contact us to obtain advice specific to your circumstances. Call 07 5597 3366 or send an email to law@belllegal.com.au