Personal Guarantees & Traps to Avoid

Business-lady

Personal-guarantees

Newsletter 4
Practice Note: 25/08/2021

Common mistakes people make when providing a personal guarantee are:

1) They do not put an expiry date on the personal guarantee.
2) They do not put a dollar limit on the personal guarantee.
3) They do not rule out the clause which gives a charge over any real estate the person owns or may own in Australia.
4) They do not keep a record of personal guarantees given.
Comment: Providing a personal guarantee with a charging clause and without an expiry date and dollar limit, is tantamount to providing an open cheque secured by the director\’s house.
Our Experience: When a company becomes insolvent, directors normally first feel financial pressure from creditors relying on the director\’s guarantee to recover payment.

More generally, common causes of financial pressure felt by a director of an insolvent company are:

a) creditors chasing payment, utilising the personal guarantee they were given by the director.
b) Director Penalty Notice issued by the ATO to the director, requiring payment of monies owing by the company to ATO.
c) the potential for a liquidator\’s insolvent trading claim if the company is placed into liquidation.
This financial pressure borne by the director can be reduced if:
1) personal guarantees are not given without first obtaining legal advice and limits applied.
2) company tax liabilities are reported to the ATO within required timelines.
3) The company is not traded while insolvent.
Example: Examples of how a personal guarantee may be limited and examples of possible issues to consider when reviewing a personal guarantee.
Observation: It is common for directors to sign personal guarantees when all is good and there is no suggestion that the company will become insolvent. This typically results in personal guarantees being poorly considered, causing the director significant pain if the company becomes insolvent.
TIP: We recommend that before directors sign a personal guarantee they obtain legal advice. Issues to consider are striking out the charging clause on real estate the director owns, or may own, in the future and limiting the personal guarantee with a dollar limit and expiry date.
Personal guarantees are a necessary evil of doing business. However, they should not be recklessly provided.

Risk Management:

A couple who jointly own their home should not both be directors of their company – causing them both to provide personal guarantees.

Comment: Personal guarantees can cause the company’s financial problems to quickly pass to the director and, if a charging clause exists, for the director’s properties to be immediately encumbered by caveat. This may limit the director’s options/flexibility for restructuring the debt and business operations.

This newsletter is provided as general information only and is not advice. If you have questions or would like to have a chat about bankruptcy and personal guarantees you are welcome to give us a call on 1300 764 197 or hello@understandingbankruptcy.com.au