assignment of a personal guarantee

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• Sep 15, 2023

Understanding Personal Guarantees: Specificity and Enforceability

Introduction

A personal guarantee is a legal commitment where an individual agrees to be responsible for a company's debt or performance under a contract if the company fails to pay or perform. In the state of Florida, personal guarantees are often used in business transactions, particularly in situations where a small business is seeking a loan or entering into a lease agreement. Understanding how personal guarantees are created, enforced and interpreted by the judiciary – which is the ultimate goal – is necessary before signing one or having someone sign one that you may seek to enforce.

This article aims to provide an overview of personal guarantees in Florida, focusing on their specificity and enforceability.

What are Personal Guarantees?

A personal guarantee is a legal instrument that allows a lender, landlord, or other party to recover a debt from the personal assets of a guarantor if the principal debtor defaults on its obligations. In essence, it is a promise made by a third party (the guarantor) to pay a debt or fulfill a commitment if the primary obligor fails to do so. The promise is the guaranty whereas the agreement itself is referred to as the guarantee.

In Florida, personal guarantees are commonly used in business loans, commercial leases, and other business transactions. They provide an additional layer of security for the creditor, as they can pursue the guarantor's personal assets if the business fails to meet its obligations. The principal is the entity that is primarily responsible for repaying the debt. The guarantor is the individual that personally guarantees performance of the principal’s contractual obligations, which typically entails payment. The rights and responsibilities of the parties, as discussed further in this article, can vary greatly depending on the contractual language.

When to Seek a Personal Guarantee

Institutional lenders and large companies often request personal guarantees if they believe the company may be unable to meet its financial obligations. However, every business needs to assess and hedge risk. Part of this process includes determining when a personal guarantee may be necessary.

In the world of small business, there are several circumstances where the request for a personal guarantee might arise. This is particularly common when the business is seeking financial assistance or entering into contractual agreements. For instance, when a small business applies for a loan, especially if it's a startup or lacks a robust credit history, lenders often require a personal guarantee from the business owner. This provides the lender with an added layer of security, ensuring that the loan will be repaid even if the business encounters financial difficulties.

Similarly, when leasing commercial property, landlords may request a personal guarantee from the business owner. This acts as a safety net for the landlord, ensuring that the rent will be paid regardless of the business's financial status. Additionally, suppliers may require personal guarantees before extending credit for the purchase of goods or services.

In essence, a personal guarantee serves as an additional financial safeguard for the party extending credit or entering into a contract with the business. However, it's crucial for small business owners to understand that providing a personal guarantee means potentially putting personal assets at risk if the business cannot meet its obligations. Therefore, it's always advisable to seek legal counsel before signing any personal guarantee to fully comprehend the potential implications and risks.

Specificity of Personal Guarantees

Florida law requires personal guarantees to be in writing and signed by the guarantor. However, the law does not prescribe a specific form or language for personal guarantees. The terms of a personal guarantee can vary widely depending on the circumstances of the transaction and the negotiation between the parties.

Despite the lack of a prescribed form, it is crucial for a personal guarantee to be specific and clear. It should clearly identify the guarantor, the primary obligor, the creditor, and the obligations guaranteed. It should also specify the extent of the guarantor's liability, whether it is limited to a certain amount or unlimited, and whether it is a continuing guarantee or limited to a specific transaction.

Enforceability of Personal Guarantees

In Florida, personal guarantees are enforceable if they meet the basic requirements of contract law, including mutual assent, consideration, legality of object, and capacity to contract. If a personal guarantee is vague or ambiguous, a court may interpret it against the party who drafted it, usually the creditor.

If a business defaults on its obligations, the creditor can sue the guarantor to enforce the personal guarantee. The creditor must prove the existence of the personal guarantee, the default by the primary obligor, and the amount of the debt. If the creditor prevails, it can obtain a judgment against the guarantor and enforce it against the guarantor's personal assets. It is important to note that it is the obligation of the creditor to show that all conditions to the guarantor’s liability have occurred or been performed prior to filing of the lawsuit. This obligation includes showing that the value of the assets received as collateral was insufficient to cover the entire debt.

Conditional vs. Absolute Guaranty

The creditor has no obligation to seek repayment of the debt from the principal before pursuing the guarantor if the guarantee specifies that the guaranty is “absolute.” A conditional guarantee, on the other hand, requires the creditor has acted with due diligence to collect the debt from the principal but is unable to collect the amounts due. In fact, a court may conclude that the guarantor was discharged if the creditor unreasonably neglects to proceed against the principal. In the same vein as the conditional guaranty, the courts have also held that if a creditor is negligent in protecting, enforcing or securing collateral for the debt, such as real or personal property and accounts receivable, that the debt or guarantor may be discharged.

A breach of a guarantee giving rise to a cause of action typically occurs when the principal defaults followed by the subsequent refusal of the guarantor to pay the debt. It follows that the best practice even if the guarantee is absolute is to make formal written demand for payment from both the principal and guarantor.

Debt Exceeds the Guarantee

A guarantee is not void if the debt exceeds the personal guaranty. Even improper or excessive charges in derogation of the contract do not relieve the guarantor of the obligation under the guarantee. However, the guarantor under these circumstances can only be held liable to the extent of the guaranty.

Modifying Terms of the Contract

If the terms of the contract are changed in a material way, the creditor should obtain the assent of the guarantors to the new terms. Otherwise, the courts may deem the guarantee unenforceable. A guarantor’s refusal to execute a new guarantee does not constitute revocation of the guarantee in existence.

Attorney’s Fees and Costs

Unless the guarantee specifies that the guarantor is liable for attorney’s fees and costs, the creditor may be unable to collect these significant expenditures that it made in pursuit of the debt.

Personal guarantees play a vital role in Florida's business transactions, providing creditors with an additional layer of security. However, they also pose significant risks to guarantors, who may be personally liable for a business's debts. Therefore, it is crucial for guarantors to understand the terms of a personal guarantee before signing it and to seek legal advice if necessary. Contact the legal experts at VAdam Law with any questions regarding your company’s contracts, including personal guarantees.

If you would like to learn more about VAdam Law and schedule a free consultation, visit our online scheduling portal or call 24 hours a day at (954) 451-0792.

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Limited liability protections afforded by various corporate, limited liability, or limited partnership laws normally insulate business owners from personal liability for their business's debts.

However, lenders routinely require a small business owner to sign a personal guaranty as a condition for a commercial loan to the business entity, essentially circumventing the statutory protection against personal liability. 

What is a Guaranty?

A guaranty is a contractual agreement in which a person (or an entity) agrees to pay the debts of another. In order to be enforceable, the guaranty must be in writing and signed by the guarantor or some other party legally authorized by the guarantor.  The guarantor becomes obligated to repay the borrower's loan, regardless of whether the guarantor is directly involved in the loan transaction between the lender and the borrower.

Lenders require guaranty agreements as a way to ensure the business loan is repaid timely. In addition to having more assets from which to receive payment, lenders also believe that if a business owner puts the owner's own personal assets and income at risk, the owner will be much more likely to treat repayment of the business loan as a priority. 

Often times, the guaranty is simply a necessary risk that a business owner must take in order to obtain a business loan. If the borrowing business entity continues to make its loan payments under the terms of the loan, then typically, the guarantor need not worry about the lender enforcing the guaranty even though it usually would have the right to do so.  However, if the borrower fails to repay its debt, then the lender will be entitled to enforce the guaranty and seek repayment from the guarantor's personal assets and income.

A guarantor who does not read the terms in a lender's requested guaranty agreement or seek more suitable terms can become directly liable for the borrower's obligation. For example, if the lender tenders a guaranty agreement containing language that provides that the guarantor will be "directly and primarily liable" for the obligation, then the lender does not have to wait for the borrower to default before suing the guarantor for the debt.  In essence, this language converts the guarantor into a borrower.

How the lender may proceed, and to what extent the guarantor can be held liable can hinge on several common provisions which may be contained in the guaranty agreement. Any potential guarantor should read a proposed guaranty agreement carefully and understand each contractual provision.  Often the terms can be negotiated, even if a business entity is a startup and has limited assets and income.

What is a Continuing Guaranty?

While some guaranties may only subject the guarantor to liability for a single obligation, lenders will often propose a guaranty that will remain in effect for an indefinite time and guaranty all of the borrower's past, current, and future obligations to the lender, as well as any renewals or extensions to those debts.

For example, the proposed guaranty agreement may state that the indebtedness guaranteed includes:

all of the principal amount outstanding from time to time and at any one or more times, accrued unpaid interest thereon and all collection costs and legal expenses related thereto permitted by law, attorneys' fees arising from any and all debts, liabilities, and obligations of every nature or form,  now existing or hereafter arising or acquired  that borrower individually or collectively or interchangeably with others, owes or will owe lender. 

This language makes the guarantor liable for:

• The borrowing entity's unpaid debts to the lender which existed prior to the guaranty and perhaps prior to the time the guarantor obtained an interest in the entity;
• The loan which the borrowing entity is in the process of obtaining from the lender; and,
• Any and all future loans or debts the borrowing entity owes to the lender, including any debts that arise after the guarantor no longer has any interest in the borrowing entity.

While a guaranty of a specific obligation, in contrast, generally terminates once the obligation is satisfied, a continuing guaranty will remain in effect until the guarantor terminates the agreement by providing written notice to the lender. This means that even if all existing obligations have been satisfied, the guarantor will continue to be held liable for any future obligations the borrowing entity incurs from the lender if the guarantor has failed to provide proper notice of the intent to terminate the agreement before any subsequent loan is made or debt incurred.  This can prove especially problematic if an owner-guarantor pays off the business's loan that was made during the time the owner-guarantor had an interest in the business, then sells the business, but forgets that the continuing guaranty exists!

Typically, the guarantor must follow the specific instructions contained in a continuing guaranty agreement before a termination is effective. If the continuing guaranty agreement is properly terminated, the termination will only be effective on additional obligations of the borrower which it incurs  after  the termination date.  The guarantor will remain liable for the full outstanding balance of all existing debts, including all interest and fees, owed by the borrowing entity to the lender.  In order to be truly free of the effects of the continuing guaranty agreement, the guarantor and/or borrower must be prepared to satisfy those existing obligations in full. 

Unlimited and Limited Guaranties

An  unlimited  guaranty does not limit a guarantor's obligation to a particular time period or amount.  On the other hand, a  limited  guaranty will hold a guarantor liable only up to a specified amount of debt, up to a certain point in time, or only on certain specified loans. 

A common use of a limited guaranty involves a small business entity that has more than one owner. Negotiations with the lender may result in each owner-guarantor's liability being limited to a percentage of the borrower's obligations equal to, or greater than, each guarantor's percentage of ownership interest in the business, but not the full amount.  In some cases, however, a lender may insist that the total amount of guarantor liability exceed 100% so that the lender will have a cushion if one or more of the owner-guarantors have insufficient assets to ante up the owner's entire share.  Alternatively, a limitation can be as simple as a limitation of "no more than" a specific amount, which is less than the entire amount of the debt owed.  Obviously, the relative bargaining power of the borrower and the owner-guarantor(s) will determine the result of the negotiation, but it is more common than it should be that the owner-guarantor just signs what it is in the initial loan documents without asking for less burdensome terms.

Joint and Several Liability

It can be easier for a business to obtain a loan if multiple individuals are prepared to guaranty the debts of the business. For example, all four owners of a small startup business may agree to give unlimited guaranties to a lender.  However, that does not mean that each guarantor is only liable for their pro-rata share (in our example, 25%) of the overall debt.  Most guaranties contain "joint and several" liability provisions, and even if the guaranties are silent on the matter, North Carolina law imposes joint and several liability on guarantors.  That means that unless the guarantors are liable for a specified amount under a limited guaranty, the lender can hold each individual guarantor liable for the full amount of the borrower's obligation.  Moreover, the lender can choose to sue only one or any number less than all of the guarantors for that full amount, leaving the guarantors to fight amongst themselves to ensure the debt is apportioned fairly.

For example, if a co-guarantor declares bankruptcy, is released from liability by the lender, or simply disappears, the remaining guarantors (or those that the lender chooses to sue) will each remain fully liable for the entire amount of the guaranteed debt. In the event that one guarantor pays, or is forced to pay, the debt in full, that guarantor can seek a claim for "contribution" against their co-guarantors in order to recover those guarantors' portion of the debt.  But no guarantor can force the lender to look to another guarantor for part payment.

The Obligation of Contribution

When two or more individuals guaranty a borrower's obligation and one or more pays, or is forced to pay, more than their relative share, the guarantor who pays more has the remedy of an action for contribution. This action is based on the law recognizing an implied promise by each guarantor to contribute their fair share to the payment of the guaranteed debt in order to meet their common obligation.  Just because the lender chooses to sue only one or less than all of the guarantors, the remaining guarantors are not excused from paying their share of the debt.  Contribution allows the co-guarantors who had to pay more than their fair share to sue to recover from those that did not.

Guaranty of Payment vs. Guaranty of Collection

Guaranty agreements commonly provide that the guaranty is for "payment" and not simply a guaranty of "collection." If the agreement states that it is a "guaranty of payment," then the lender can seek recovery of the debt directly from the guarantor without first pursuing the borrower. On the other hand, if the agreement states that it is a "guaranty of collection," then the lender must exhaust the lender's remedies against the borrower before the lender can seek recovery from the guarantor.  Due to the flexibility that a guaranty of payment grants the lender, almost all guaranties tendered by lenders specifically state that they are of "payment."  It would be rare for a lender to agree to a guaranty of collection only, but, depending on the facts and circumstances, a savvy guarantor of a loan to a prosperous business might be able to negotiate this term.

Lender's Right to Set-Off

If a guaranty agreement provides the lender with a right to "set-off," it means that the lender can "take" funds from the guarantor's account (except for certain IRS or trust accounts), without prior notice, to satisfy the borrower's past due debt.  

For example, a guaranty agreement may state that:

Lender reserves a right of set-off in all of guarantor's accounts with lender including all accounts guarantor may open in the future. Guarantor authorizes lender, to the extent permitted by applicable law, to hold these funds if there is a default and apply the funds in these accounts to pay what guarantor owes under the terms of this guaranty. 

By signing a guaranty agreement with such language, the guarantor is granting the lender permission to withdraw personal funds from the guarantor's account(s) as credit against the obligation of a defaulting borrower.

Death of a Guarantor

Most guaranties survive the death of the guarantor, and any liability will become part of the guarantor's estate. As stated earlier, the only way to avoid liability is by paying the obligation(s) in full, or obtaining a release from the lender.  Typically, a lender will not release an estate from liability, unless the lender agrees to allow another party acceptable to the lender to take the deceased guarantor's place.  It's possible to negotiate a release, or release and replacement, upon death provision in a guaranty agreement if certain factors exist, but such provisions are usually very detailed and require the assistance of an attorney or other professional to draft them.

Before you sign any guaranty agreement, be sure to read all of the terms carefully. Guaranty agreements can easily bind you to more debt than you intended.  Prior to signing, you should always obtain independent legal advice from a licensed attorney who will make sure your intentions are adequately reflected or that, at least, you understand your risks before you sign.  Otherwise, you may find yourself taking on much more than you anticipated.

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When is a Personal Guaranty Unenforceable? A Guide for Startups 

What is a personal guaranty?

A “ guaranty ” is a promise to answer for the pay ment of a nother person’s debt if that person fail s to make payment in the first instance . One who promises to fulfill a guaranty is called a “guarantor.” For example, a parent who agrees to co- sign for their child’s car or student loan is the guarantor of those obligations . In the case of your busine ss and its application for financing, your personal agreement to repay the loan if your business cannot do so means that you’ve given a personal guarantee.  

What liabilities are you assuming when you sign a personal guaranty?

When you sign a personal guaranty on behalf of a business, you agree to be personally responsible for repaying the business’s creditors in the event that the business itself becomes unable to do so. 

Here’s a scenario that could play out:  

• Your business needs equipment to manufacture and sell widgets.  
• Your business applies for a loan to buy that equipment. The equipment your business purchases is pledged as collateral to secure the loan obligation, and the bank takes a security interest in it; the loan agreement may also require you to personally guarantee your business’s obligation to repay the loan.  
• Unfortunately, your business fails, and you can’t make payments on the debts as they come due.  
• The bank sues your business for defaulting on its payment obligations, and you are individually named as a party in that lawsuit because you are a personal guarantor.  
• You will be personally liable to the extent that the value of the collateral is insufficient to cover the outstanding loan obligation.  

When you sign a personal guaranty for your business to receive a loan, you pledge your personal assets as collateral, including your home, the cash in your personal checking account, your savings and investments, and your future wages, which the bank will attempt to garnish.  

Note that some insurance products may provide coverage for losses sustained from personal guarantees. Consult with your insurance agent for more information

Did you know we offer a free tool to help business owners limit unwanted litigation? It’s called the CM6 CheckUp. Take your free assessment today.

Factors influencing the enforceability of a personal guaranty

Personal guarantees are a requirement of many business contracts . E ntrepreneurs and business owners should understand the potential consequences of signing one. It may also be helpful to understand whether an argument against the enforceability of a particular personal guaranty exists. Even large banks or other institutions sometimes overlook fundamental requirements .  

The personal guaranty must be evidenced by a written instrument

In Ohio, any agreement to answer for the debt of another person must be evidenced by a written instrument ( See R.C. 1335.05 ). If your business receives demand correspondence alleging that you have personally guaranteed your business’s debts , demand a copy of the written instrument allegedly evidencing the personal guaranty . One who seeks to enforce a contract of c ourse bears the burden of proving that it , in fact, exists.   

The written instrument must be signed by the guarantor in the guarantor’s personal capacity .

To be enforceable as a personal guaranty, the signatory must sign the guaranty in his or her personal capacity and not as the “president” or “CEO” of the company receiving the loan, which is its own legal entity, separate and apart from the people that run and operate it.  

If the personal guaranty is not evidenced in writing, and if such writing was not signed by the alleged guarantor in his or her personal capacity, then there are strong arguments against its enforceability.  

A personal guaranty is unenforceable without adequate consideration .

In fact, no contract is enforceable without adequate consideration. A personal guaranty is a type of contract. A contract is an enforceable promise. The enforceability of a contract comes from one party’s giving of “consideration” (something of value) to the other party. In the case of a loan agreement involving a personal guaranty, the bank gives a loan (which is valuable to the business applying for it) in exchange for the guarantor’s promise to repay it (which is valuable to the bank as a hedge against default).   

In a lawsuit to collect a debt, a creditor must prove that it has the right to collect the alleged debt. As mentioned above, some creditors simply cannot produce documents evidencing their alleged right to collect; this may be attributable, at least in part, to the number of times that loans are repackaged and resold.   

Can a personal guaranty be revoked later?

An otherwise valid and enforceable personal guaranty can be revoked later in several different ways. A guaranty, much like any other contract, can be revoked later if both the guarantor and the lender agree in writing. Some debts owed by personal guarantors can also be discharged in bankruptcy.  

Many factors can affect the enforceability of personal guarantees. If you have any questions about the enforceability of a personal guaranty that you have signed, or if you are considering signing one to get financing approved, please consult with one of our experienced Ohio business law attorneys who will assess your case and offer thoughtful legal guidance to support your decision.  

Maximilian Julian is a partner at Gertsburg Licata.  He may be reached at (216) 573-6000 or at [email protected] .

Gertsburg Licata is a national, full-service business law and strategic advisory firm offering a full range of legal services. Call 216-573-6000 or contact us  here .  

This article is for informational purposes only. It is merely intended to provide a very general overview of a certain area of the law. Nothing in this article is intended to create an attorney-client relationship or provide legal advice. You should not rely on anything in this article without first consulting with an attorney licensed to practice in your jurisdiction.     

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Where are the loopholes in Guarantees?

Guarantees and personal guarantees are important - and serious - commercial documents.

When you sign one it's difficult to get out of it, when they're properly done.

But then there are things that can happen outside the contract that allow can make the guarantees and personal guarantees unenforceable.

It can be a matter of knowing the sort of thing that you're looking for.

What is a Guarantee?

They impose liability on a third party to a primary transaction (such as business loans), when the person meant to perform the obligation doesn't.

Practically any contract obligation can be guaranteed by another person, not just business loans.

Guarantees can be:

• limited to part of the obligations of the debtor
• capped to a specific amount
• limited in time
• subject to specific methods of notice
• made subject to any other limitation
• any other condition which may be agreed

“See to it” Guarantees

Guarantees are not limited to providing backing for loans of money or financing.

Guarantees can provide backing to perform of a legal obligation of another person.

It could be for the delivery of goods, services or any other contract obligation.

This is usually referred to as a “see to it” guarantee.

So a guarantee is a promise made by a one person to another to honour that the person primarily responsible for performing a contractual obligation.

What is a Personal Guarantee?

A personal guarantee is a guarantee given by an individual rather than a company.

The liability to honour the guarantee is personal to you. There's no protection from a company. This means that all of your personal assets are on the line.

Personal guarantees are attractive to creditors when the guarantor has assets to cover the exposure of the creditor.

Guarantees: Security for Performance

Guarantees are a form of security of performance of a contract.

The guarantor accepts liability to answer for the debt or obligation of another person.

The guarantor may not sign up to pay damages for the breach of performance. But guarantors are nevertheless liable to the creditor for the failure of the first person to perform.

Legal Requirements for a Guarantee

Many documents are called guarantees when they’re not.

The factors that courts take into account are:

• Proper interpretation: contracts of guarantee are interpreted “as a whole” . It is the particular words used in the relevant clauses that count. Not what it's called
• Title of document: the title of the document is not decisive
• Substance over form: Just because the word “guarantee” is used in the contract somewhere, does not make it a guarantee

Guarantee have a number of formal requirements to be a guarantee to put it beyond doubt that it is a guarantee.

• Form of guarantees: It must be evidenced in writing. The writing is may be formal contract or agreement, note, memorandum or promissory note
• Signed: The guarantor should sign it, or have their authorised agent sign it. The name may be written or printed, so long as it is intended to operate as a signature
• Secondary Liability: Establish that the guarantor has secondary liability to perform the guaranteed obligation. The principal debtor has the primary liability to perform the contract
• Consideration: The document should satisfy the requirements of any other contract. That means, offer and acceptance, consideration , an intention to be legally bound and capacity to make the contract

What makes Guarantees so special?

The parties to a contract make promises that they will do the things set out in contracts. The party to the contract is responsible for performance of promise. 

Guarantees are different. Guarantees are a promise by a person not responsible for performance of the contract.

Guarantors receive no benefit from the contract.

They expose themselves to liability of the contract for no return.

Guarantors promise that they will make good to a creditor failure by the primary contracting party to perform the contractual obligations.

So guarantees create a secondary obligation to perform the contract on the guarantor, where the primary obligor (often a debtor) fails to deliver on their contractual obligations.

For these reasons, the law imports special considerations for guarantees to be valid: the guarantor is not primarily responsible for the performance of the contract. It is outside their control. Someone else is primarily responsible.

We come to the main differences between indemnities and guarantees in a moment.

How long is a personal guarantee enforceable?

A guarantor’s liability is “coextensive” with the debtor.

Whatever the debtor is liable for to the creditor, is the liability of the guarantor. If the debtor’s liability is released, so is the liability of the guarantor.

Guarantors have all the defences to payment and/or performance available to them as the debtor.

This means two things:

• where the debtor remains liable to the creditor, so does the guarantor. If the debtor is able to show that their own liability is extinguished or reduced, the guarantor gets the benefit of that reduction.
• There may be terms in the contract of guarantee which caps the liability of the guarantor or even limits the time in which the credit can call upon in the guarantor to make good the default.

Unenforceable personal guarantees

When do guarantees become unenforceable?

In the worst case, they only become unenforceable after the relevant limitation period expires.

A limitation period is the maximum period of time allowed by the law to commence legal proceedings for breach of the contract of guarantee. But then the contract may contain time bars, which restrict the period of time within which the creditor may claim. It depends on what is said in the contract.

The general law rules are:

• for normal contracts, 6 years from the date that the breach of contract took place
• for deeds, 12 years from the date of the breach.

It's not likely that a creditor will allow this to happen.

Also, things might have happened before or after the guarantee was signed which make it unenforceable.

That's next.

Defences: How to get out of a personal guarantee

Some guarantees will have loopholes, others won't. But it's not just the terms of the guarantee that decide these things. The creditor may behave themselves in a way that prevents them from relying on the guarantee.

Some of the more common ways guarantors get out of a personal guarantee include:

• The guarantee was undermined by civil fraud , negligent misrepresentation or undue influence, because the guarantor was substantially misled before it was signed
• The creditor repudiated the contract of guarantee, and the guarantor accepts the repudiation
• The creditor has failed to tell the guarantor something that affects the relationship between the debtor and creditor
• extension on the time to pay
• increase in the sum of the debt of the debtor
• A condition precedent to the guarantee was agreed and never satisfied.
• The guarantor may have agreed to be co-guarantor. The other intended guarantor never signed the guarantee as guarantor. The guarantee was intended to be signed as one document part of a larger transaction, and those other contracts were never signed. In each case, the contract would not come into existence in the first instance because the condition had not been satisfied.
• that asset does not exist, and
• no other form of security can be identified as a substitute
• Each of the parties have operated under a common mistake
• The guarantor has acted under economic duress. The practical effect of the pressure is that there is compulsion on or a lack of practical choice for the guarantor.  The pressure must be illegitimate, as opposed to "the rough and tumble of the pressures of normal commercial bargaining.". It's a high standard to satisfy.
• The Unfair Contract Terms Act 1977 applies to relieve the guarantor of onerous terms of the guarantee
• The contract of guarantee is illegal on some basis

As you can imagine, creditors take guarantees seriously. We've never known a creditor to forget that they have received a personal guarantee for debt, whether by a company director or anyone else.  They will prepare the guarantee document to make sure their interests are protected. Usually.

Reduction of amounts owed

The liability of guarantors can be reduced to the extent that:

• The debtor discharges the financial liability to the creditor
• A damages claim for misrepresentation caused the guarantor to enter into the agreement, was albeit not fraudulent, but negligent
• Breach of an implied term of the contract to take reasonable care to ensure that the price at which property is sold is the best price that can be reasonably obtained for the security given under the guarantee

Proper Interpretation of Guarantees

Liability under the guarantee is determined by what is known as a "proper interpretation" of the contract of guarantee.

Legal obligations of guarantors are interpreted from the standpoint of a commercial perspective of a reasonable person, knowing what the parties to the guarantee knew as at the date of the contract. Here's a guide to reading contracts .

It has to be said that it's tough to avoid liability under a properly drafted guarantee. It narrows your options.

Whether you can get out of a personal guarantee often depends on what happened before the guarantee was agreed and what has happened since it was signed.  

In hard cases, this means that you can't tell whether you can get out of a guarantee without:

• reading the contract of guarantee and the terms of the guarantee; and
• knowing what actually happened before and after the contract of guarantee was agreed: ie all of the relevant facts of the case.

Whether or not a guarantee is enforceable is highly fact specific – a slight change of the facts can mean the difference between success and failure.

Limited Opportunities to get out

If you do get an opening to get out of a guarantee, that window of opportunity can be short before it closes on you.

Interpreting Guarantees: Loopholes

Frequently, contracts contain obvious ambiguity.

When the facts of the case have come to pass (by the time courts come to consider them), they often contain latent ambiguities.

That is, the contract can be interpreted in more than one way.

Differences in interpretation - or “the construction of the contract” – may mean the difference between success and failure of the guarantor avoiding liability.

It’s important stuff if you’re a guarantor who believes that it would be wrong for you to be liable.

Owing in part of the special nature of the contracts of guarantee, courts take a “strict” approach to interpretation. The means that clear words – in the legal sense - must be used in the guarantee.

If there is ambiguity, it is likely to work against the creditor.

The reasons for doing so include:

• side-stepping attempts to exclude the application of general law requires clear and unambiguous language
• the creditor drafts the contract. It presents it to the proposed guarantor to sign.

As a consequence, the contra proferentem rule of interpretation applies so that ambiguities will be interpreted against the creditor. 

The Court considers all the surrounding circumstances of the case, particularly as at the date the contract was signed.

The state of affairs and knowledge of the parties as at the date of the contact play an important part in the outcome. This is because the Court uses the information to clarify the scope and extent of the guarantee., and therefore the obligations of the guarantee.

In Liberty Mutual Insurance Co (UK) Ltd v HSBC Bank plc [2002], it was said in respect of interpretation of contracts:

…. against the background of admissible matrix of facts known to or at least reasonably available to the parties, the meaning sought is that of the language in question would convey to the reasonable man. In that context, the language used is to be given its natural and ordinary meaning, unless a reasonable man would conclude that something has gone wrong in expressing the parties’ intentions.

What this means is that courts have the power to:

• consider evidence outside the contract to ascertain who was to receive the benefit of a guarantee
• interpret a contract so as to correct a mistake in its preparation
• see past allegations which are not supported by documentary evidence, but merely oral evidence
• ignore words which attempt to exclude or limit the application of the general law, which would be to the advantage of the guarantor

Example Guarantee Clause

In an appropriate case, a guarantee clause might be worded as follows:

The Guarantors hereby guarantee to [creditor] the due and punctual performance of all present and future obligations of [the debtor] to pay the monies payable to [creditor].

Guarantees in contracts are rarely this straightforward or simple.

Personal guarantee wording

The wording of a personal guarantee could be the same as the simple example above. The guarantors would be individuals, not companies.

What is a personal guarantee on a business loan?

Suppose a friend wants to take out a business loan with a bank to start a business.

The bank insists it receives a guarantee for the repayments of the loan, before it gives the loan to your friend. You offer to be the guarantor.

If your friend then defaults on the repayments of the loan, the bank can call upon you to pay the outstanding sums on the loan.

This is one of the simplest forms of guarantee. Because you have guaranteed the loan in your own name (and say, not through a company), it is a personal guarantee. That means all of your personal assets are available to the bank to recover against, if your friend defaults on the loan.

Being a Guarantor for a Loan

Personal guarantees attract so much risk - if things don't go as they are expected - that directors of businesses and other giving them in a business environment take out personal guarantee insurance .

Directors' Personal Guarantees

Directors of companies are often requested by banks to provide personal guarantees for sums lent to companies which they control: ie director's guarantees.

This situation is quite similar to the example above. When the director gives the guarantee, if the company can’t service the loan, the director is called upon for the sums owed on the loan. They're personally liable under the director's guarantee.

• A director of a company might personally guarantee to the bankers of the company or loan provider that all the loans given to the company will be paid by the company.
• If the company defaults on payments or becomes insolvent, the bank or loan provider can look to the director to repay the loans given to the company, on the strength of the director's guarantee.
• A company director might give a performance guarantee to a service provider to the company that some state of affairs will exist throughout a contract between the service provider and the company. This is a “see to it” guarantee.

Director's Liability for Company Debts

Directors personal liability for company debts is not relieved or avoided when the company enters liquidation or administrative receivership, and can no longer service the loan. In fact, these are precisely the cases where lenders call on guarantors and their personal assets to reply the loan(s) given to the company.

Recovery proceedings by lenders for company debts isn't piercing the corporate veil . The guarantee and/or indemnity is a freestanding contractual commitment with privity of contract between the lender the guarantor to pay the debt, and probably the expenses incurred by the lender to chase the debt.

Recovery by Creditor from Guarantor

When a creditor recovers money from the guarantor because the debtor has defaulted on (say) a loan, the debtor (say a company) is then liable to the guarantor for sums that the guarantor has paid the creditor.

The liability of the guarantor is said to be “secondary”.  This is because liability arises in the guarantor at the request of the creditor. The guarantor assumes liability when the debtor fails to perform and the guarantor is called upon to honour the guarantee.

What is an Unlimited Personal Guarantee?

It's a guarantee that has no upper limit or cap on the amount that the creditor can recover under the guarantee from the guarantor.

Upper limits on recovery under a guarantee can be imposed by stating them in the contract. These sorts of clauses are known as limitations of liability, limitation clauses or exclusion clauses. 

Is it a Guarantee? Guarantees vs Indemnities

There are significant differences between a guarantee and an indemnity .

In a well drafted guarantee, it will usually include a guarantee and an indemnity.

A person who indemnifies another party to a contract promises to compensate them if a particular state of affairs does not come to pass, and the contracting party suffers loss as a result. They are directly contractually required compensate the other party for their loss – they are “primarily liable”. Contract indemnity clauses are easy to spot - they usually use the word "indemnify" and/or "hold harmless". They, like guarantees may give rise to joint and several liability with the debtor company.

So an indemnity is an express contractual obligation to compensate for any loss suffered, independent of what the liability of the party in breach might otherwise be to a third party to the contract.

Guarantees and Secondary Liability

In contracts of guarantee, the guarantor assumes secondary liability. The guarantor answers for obligations for which the debtor, who remains primarily liable.

This means a guarantor is liable for (say) the debt regardless of the position of the debtor, and whether a demand has been made upon the original debtor or not.

A guarantor only becomes liable when the debtor has failed to perform its primary obligations; the liability arises when the rights against the original debtor have been exhausted.

Just because a party is named as a debtor, does not mean that they cannot be found to be a guarantor as well. It depends upon the intention of the debtors, and whether they intended one to be a guarantor for the other.

Differences between Guarantees and Indemnities

Challenging personal guarantees.

Standards of behaviour by creditors can vary from guarantee to guarantee. Believe it or not, there's solid legal authority that says that no one guarantee will be interpreted in the same way for different contracting parties.

They're drafted in the main party with a view to be being challenged by a debtor in the fullness of time.

But there's only so such a draftsperson of a guarantee can do when drafting the guarantee document.

Important factors which affect enforceability of guarantees happen in the real world, not in the contract of guarantee itself.

Enforceability of  a guarantee can depend as much on the behaviour of the creditor as the terms of the contract.

Still, there's no question that the contract should be reviewed before it's signed. When the advice doesn't say what it should say, there may be a claim against the advisor.

Legal Advice on Contracts of Guarantee

We've never met a person who has a guarantee from a guarantor, and has forgotten they have it.

Guarantees in business are serious documents. Assets are at stake.

If it's a personal guarantee, they're personal assets and not just those of a company.

Is it a waste of money to ask a solicitor to look at your situation?

It depends on your objectives.

Suppose a creditor claims say £20,000 under a personal guarantee. Suppose then the legal costs for the legal advice on the guarantee for ways to challenge it are £1,700.

If the lawyer comes and says that you have no hope of defending the claim on the guarantee, it’s a waste of money, right?

Not necessarily.

What if the guarantee isn’t as watertight as you are being told it is?

What if you’re not in such a bad position as you think you are?

What if you can set yourself up with a better negotiating position to?

What if as a result of the advice, you’re able to negotiate a lower settlement than the £20,000, like £6,000?

Is that a win? 

Despite what you might have heard, the open and shut case is rare - very rare - in the law. Things tend to happen on the ground, outside the legal documents - events that happen in the real world - which affect the enforceability of guarantees, and weaken the position of creditors.

The people working for the creditor may not know what they do when signing guarantors up or how they treat guarantor after it is signed may hurt the the creditors' legal position. 

That may be the case with yours.

If you’ve got a budget to defend a guarantee, and the creditor is hassling you for payment before they move to enforce it, you have a limited opportunity to do something about it.

When creditors start legal proceedings, things moves forward. Fast.

That’s not the ideal time for you to size up your options.

The earlier you address the issue, the less sunk costs the lender has in chasing unpaid money, the less effort and expense has been incurred chasing it. Emotions can run high by the time it comes to starting legal action. The lender might be far less willing to compromise at a later stage.

If you don’t take advice early - or at all - you’re no better off and won’t find out if there’s a way to crack the guarantee and:

• improve your position
• negotiate a better deal in time or money
• buy time to preserve your assets

Drop us an email on [email protected] with a copy of your guarantee, loan documentation a summary of the backstory for a cost estimate for legal advice on your guarantee.  We're business dispute lawyers that advise businesses.

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Personal Guarantee (Guaranty) for a Lease Agreement

A personal guarantee form , or “co-signing agreement”, is a document that makes the signer personally liable for the performance of a lease agreement, whether or not they are the tenant. A personal guarantee is common when singing on behalf of a residential tenant that doesn’t have the financial capability to be approved for a lease and for commercial leases. After signing, the personal guarantee should be attached to the lease with copies given to all parties.

The signer is known as the “guarantor.”

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Limits on the Protection of a Personal Guarantee

The Benefit of a Personal Guarantee When Extending Credit

Many of our clients, whether in the construction industry or another commercial context, require the unconditional personal guarantee of a company owner before entering into a contract. The insistence on a personal guarantee (often written as “guaranty” in many financial documents) most commonly arises when credit or financing is being extended to a customer or client. While securing a personal guarantee in these situations is a good way to protect against the risk of default by a corporate entity, it is important to understand its limitations.

Limitations of the Personal Guarantee

Primarily, it should be kept in mind that if the person giving the guarantee, known as the “guarantor”, has bad credit and limited means to satisfy the obligations for which the guarantee is being given, the guarantee will not offer much protection. Leaving aside this overarching problem, there is a less obvious limitation that arises after the decision to extend credit and accept a personal guarantee has already been made. Specifically, that a personal guarantee in New Jersey is generally not enforceable as to credit extended after the person who provided the personal guarantee files for bankruptcy and obtains a bankruptcy discharge.

The Impact of Bankruptcy on the Personal Guarantee

As most people with a rudimentary understanding of the bankruptcy process know, with certain exceptions, debts owed by a debtor existing prior to the filing of a bankruptcy petition no longer exist once a debtor obtains a bankruptcy discharge. But what happens to the personal guarantee itself? If credit is extended after the bankruptcy to the company benefiting from the guarantee, is that debt still guaranteed by the personal guarantee signed before the bankruptcy? In New Jersey, the short answer is no.

Primarily, the pre-petition guarantee is likely to be deemed subject to, and terminated by, the bankruptcy discharge because it falls within the definition of a pre-petition contingent claim against the bankruptcy estate. As the United States Bankruptcy Court for the District of New Jersey has explained,

The issue of whether an obligation must be designated as a pre-petition or post-petition claim does not depend on when the damages from the harm accrued. Rather, the issue is when the cause of action arose. The cause of action arises when a cognizable "interest" arises, i.e., when "a legal relationship relevant to the purported interest from which the interest may flow" is established. Schweitzer v. Consolidated Rail Corp. , 758 F.2d at 943; In re Radio-Keith-Orpheum Corp. , 106 F.2d 22, 26-27 (2d Cir.1939), cert. denied , 308 U.S. 622 (1940).

In re Gullone , 301 B.R. 683, 687 (Bankr. N.J. 2003).

In In re Radio-Keith-Orpheum (“RKO”), a case discussed in Gullone and elsewhere by the Third Circuit, the establishment of the pre-petition legal relationship between the debtor and the claimant in the form of guarantor-guarantee was the point at which the contingent claim arose. In RKO, the post-petition default of the primary obligor did not reinstate the debtor's pre-petition guarantor obligation, which was discharged in the debtor's confirmed reorganization plan. While the relevant case law identifies some theories that would support exceptions to the discharge of a pre-petition personal guarantee, no such exceptions have been specifically recognized in the Third Circuit to date.

The Importance of Knowing When a Personal Guarantee Is No Longer Enforceable

Given the state of the law, or even generalized assumptions about bankruptcy, a creditor, upon hearing of a guarantor’s bankruptcy, might respond by ceasing to extend credit to a company, rendering the pre-bankruptcy personal guarantee irrelevant. However, there are number of scenarios in which the creditor would understandably have other reactions:

• The creditor may be unaware of the guarantor’s bankruptcy.
• The company benefiting from the personal guarantee may be able to honor its obligations despite the bankruptcy of the guarantor.
• The creditor’s contract with the company, as could be the case in a commercial lease, may require the creditor to continue performing during and after the guarantor’s bankruptcy proceedings.

One can also conceive of scenarios where, even if the creditor temporarily ceases to extend credit as a result of the guarantor’s bankruptcy, there may be business reasons for resumption after the discharge. In any of these scenarios, the important thing to realize, at least in New Jersey, is that the bankruptcy discharge will in most situations operate to terminate the personal guarantee that existed prior to the guarantor’s bankruptcy filing. Accordingly, while abiding by the rules protecting bankruptcy debtors, it is advisable to secure a new guarantee from the guarantor after the bankruptcy or obtain an alternative means of security for the company’s debt or other contractual obligations.

The Law Office of Bart J. Klein , located in Maplewood, New Jersey, counsels clients throughout New Jersey regarding contract and construction related disputes. Our staff includes construction lawyers and commercial litigation lawyers. We welcome you to contact us for further information.

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Personal Guarantees – Options for guarantors

• Patrick Selley
• Banking & Finance
• Dispute Resolution

Banks are under considerable pressure to reduce risk and improve profitability. One effect of the banking crisis of 2008 is that banks now increasingly require personal guarantees from borrowers – and in particular SME (small and medium-sized enterprise) borrowers. This gives a fallback recovery option in the case of default, shielding banks from some of the risk of lending. Banks are often quick to call such guarantees.

This has led to a steep rise in bank guarantee litigation, but interestingly has also seen a considerable number of successful challenges to personal guarantee claims from guarantors. This article reviews some of the defences that may be available to business owners who find that they have given personal guarantees and whose assets are now ‘at risk’.

What is a personal guarantee?

As the name suggests, a guarantee is a contractual promise to pay the liabilities of another. The guarantor is typically a shareholder, director or group company with assets. The debtor is typically the guarantor’s company. A guarantee can be an obligation either to pay the liabilities of the company or to ensure that the company performs its obligations to the lender.

A guarantee is therefore essentially a contract and in particular a contract of ‘suretyship’. Because the surety (guarantor) may not necessarily be directly involved in the primary relationship between the borrower (company) and the lender (bank), the law of suretyship, through principles of equity, has developed to permit additional defences to guarantors in certain circumstances.

If you find that you are facing a demand on a personal guarantee, then you need to analyse the situation systematically to see how best to respond to the bank or other creditor making the demand.

Although the law does afford specific additional protection to a guarantor, the starting point should always be to examine the position in accordance with the principles of English contract law. English contract law has evolved over centuries and provides a series of complex rules governing all contracts. Certain breaches of these contractual principles will cause the relevant contract (in this case the personal guarantee) to be void and/or unenforceable.

All guarantees must be given for ‘consideration’

For any contract (as opposed to a deed) to be binding, there must be consideration. Consideration is the legal term for the benefit of the contract. The most common form of consideration is the payment (in kind or in cash) for the subject matter of the contract, whether it be rights, goods, services or otherwise. In the case of a guarantee, the consideration is usually the agreement of a bank to lend, or to continue to lend, to a third party (the business). Courts do not assess the adequacy of consideration, only its sufficiency ( Chappel v Nestle [1960] AC 97). This means that even if the loan being given in exchange for a guarantee does not seem objectively favourable, it will generally be treated as valid consideration.

However, if the loan is already in existence at the time of granting the guarantee, or if the bank is obliged to continue lending because it has no legal basis to call in the loan at that time, there may be no consideration and accordingly no liability. Eastwood v Kenyon (1840) 11 Ad&E 438 is long-established authority for the rule that ‘past consideration is no consideration’.

All guarantees must be in writing

A guarantee has to be in writing and signed by the guarantor or some party authorised by the guarantor (Statute of Frauds 1677). It is often thought that more formality is required, but in fact the formal requirements are few.

Indeed, the courts have even shown flexibility in their interpretation of the 1677 legislation. Golden Ocean Group v Salgaocar Mining Industries PVT [2012] EWCA Civ 265 confirmed that a series of documents, in this case a chain of emails, could together be construed as a valid guarantee.

The demand made must be in accordance with the terms of the guarantee

It is necessary to ask whether the demand being made is one that properly falls within the scope of the contract. Where the business undertaking is reasonably substantial there will, over the life of the business, inevitably be a number of different facilities. A bank may seek to rely on a guarantee that is quite old and was understood to relate to a particular facility that has since expired. This may not be immediately clear from the wording of the guarantee itself. It is well established in English law that contracts are to be construed with reference to the surrounding circumstances and the relative positions of the parties at the time that the contract was made.

Lord Roskill said in Hyundai Shipbuilding & Heavy Industries Co Ltd v Pournaras [1978] 2 Lloyd’s Rep 502 that the guarantee should be construed as a whole against “the factual matrix of the background”. So where the bank’s demand comes as a surprise because the guarantor considered that it related only to a particular facility that has since expired, the guarantee will need to be construed in the context of all the contemporaneous circumstances and other contractual documentation before liability is accepted.

There are two types of guarantee: those creating a primary obligation and those creating a secondary obligation. A primary obligation imposes an obligation on the guarantor actually to pay in the event of a default by the guaranteed party under the primary contract. A secondary obligation instead imposes an obligation to ensure that the guaranteed party will honour its obligations in the loan facility. This was considered in the case of Moschi v Lep Air Services Ltd [1973] AC 331.

Secondary obligations of this nature are sometimes called a ‘see to’ guarantee, that is, that the guarantor will ‘see to it’ that the debtor performs. The important difference here is that guarantees which impose a primary obligation oblige the guarantor to pay money. Failure to pay that money entitles the bank to sue the guarantor for that fixed sum of money. In the case of the ‘see to’ obligation, the bank is only entitled to sue for damages for breach of that obligation by the guarantor. Any party suing for damages is subject to the normal principles of having to mitigate loss, and therefore some enquiry of what loss the bank has actually suffered is necessary before accepting liability for the sum demanded. It is worth noting that the courts require unambiguous language in order to find that a primary rather than secondary obligation has been established, per Ultrabulk A/S v Jagatramka [2017] EWHC 2792 (Comm).

Because the nature of a contract of guarantee is that of a contract of suretyship, there are also rules of interpretation developed by the courts that afford special protection to guarantors. For example, the courts invariably hold that if certain legal or equitable rights usually available to a guarantor are to be excluded in the contract of guarantee, then very clear words must be used ( Trafalgar House Construction v General Surety & Guarantee [1996] AC 199). Where wording is ambiguous, the ‘contra proferentem’ rule may be used to interpret in favour of the guarantor and against the bank.

Encouragingly, the courts are not slow in applying business common sense to questions of interpretation. Rainy Sky v Kookmin Bank [2011] UKSC 50 establishes that courts can turn to commercial common sense whenever the plain text of a contract admits of more than one possible reading. This has been qualified slightly by Wood v Capita [2017] UKSC 24, which clarified that both textualism and contextualism are tools to reach the same goal of finding the objective meaning of a contract – but considerations of commercial common sense are certainly not off-limits.

Guarantors must not be induced to enter into a guarantee by a misrepresentation

A surety (guarantor) is not bound by his contract if it was induced by any misrepresentation by the creditor (bank) of any fact known to it and which was material to the surety, whether the misrepresentation was fraudulent or not ( London General Omnibus Co v Holloway [1912] 2 KB 720).

On the face of it, this is a potentially powerful protection for guarantors. However, its scope was construed somewhat narrowly in North Shore Ventures Ltd v Anstead Holdings Inc & Ors [2012] EWCA Civ 11. This case held that there is no duty to disclose features that are not unusual in a creditor/debtor relationship, even since the London General Omnibus decision.

Nonetheless, certain types of misrepresentation will enable the guarantor to have the guarantee set aside and any security pledged thereunder returned. There are a number of types of misrepresentation that will be relevant:

• A misrepresentation as to the state of indebtedness between the bank and the company at the time the guarantee is given

Suppose a director and business owner is called in to the bank’s offices to discuss the state of the company’s facilities and it is represented by the bank that if it is to continue to support the business, additional security, including a personal guarantee, is required. This constitutes a representation by the bank that the state of the account between it and the business is at a level that legally entities it to call in the loan facilities. There are a number of reasons why this may not be the case (see my earlier article entitled “Undue Bank Pressure”). For example, the balance owing to the bank may have been simply overstated by the unlawful application of incorrect interest charges. In this case, the bank claims that the balance is such as to put the business in default under the terms of the relevant loan facility. If interest, properly calculated, would mean no default had occurred, then the misrepresentation of the balance could be a material misrepresentation as to the state of the account. This would entitle the guarantor to have the guarantee set aside.

• A misrepresentation as to what was being guaranteed

In the case of a guarantor who was led to believe that he was simply guaranteeing a bank loan, but the guarantee as a matter of fact extended to “all debts and liabilities direct or indirect” of the principal debtor, the bank was prevented from recovering in respect of “indirect liabilities” ( Royal Bank of Canada v Hale [1961] 30 DLR (2d) 138).

Where there is a matter of particular concern to an intending guarantor who makes a specific enquiry of the bank, he must be given a true, honest and accurate answer to his enquiry.

Guarantors must freely decide to provide a guarantee

One of the key elements in any contract is the intention of the parties to be bound by it. Where a party is subject to undue influence from a third party, then this can mean that party did not have the requisite intention to contract. There are many possible types of undue influence or duress that potentially impact upon contractual obligations in general and guarantees in particular. The most common scenario in this context is where a third party (often a husband or wife of the business owner) is made a party to the guarantee of the business’s liabilities to the bank. The law has changed in recent years in relation to these situations, and is now wholly encompassed within the doctrine of “Presumed Undue Influence”.

Presumed Undue Influence arises in cases where the relationship between the parties is such as to raise a presumption that one party has exerted undue influence over the other. Certain relationships give rise to such a presumption as a matter of law. These relationships are, amongst others, husband and wife, parent and child, and doctor and patient. Otherwise, it will be determined on the facts, with a court examining the extent to which undue influence is relevant. In these cases, where there is no predefined relationship of influence, it falls upon the guarantor to prove influence on the facts. However, the ‘undue’ element still need not be proven; once a relationship of influence is shown, the presumption of undue influence arises.

If, therefore, a bank requires a guarantee to be given by a business owner and his/her spouse (who is not involved in the day-to-day management of the business), then it is to be presumed by the bank that the signature on the guarantee by the spouse has been procured by the exercise of undue influence. This is known as constructive notice, a doctrine firmly established in Barclays Bank v O’Brien [1994] 1 AC 180. Unless the bank has satisfied itself that the spouse has entered into the guarantee of his/her own free will, then the spouse’s guarantee could be set aside. To avoid this, the bank will typically require the spouse to receive independent legal advice ( RBS v Etridge (No. 2) [2002] UKHL 44). Usually banks now take the appropriate steps in these circumstances to ensure that such a party is properly advised but, surprisingly, not always!

Defences based upon the conduct of the bank after the guarantee has been given

There are a number of important equitable principles that apply to the conduct of the bank and may again have the effect that the guarantee in question is voidable. These types of defence are based upon the fact that the guarantor is not a party to the contract between the bank and the debtor and has little, if any, control over the conduct of the bank, but at the same time is directly affected by the bank’s conduct and the operation of the facility agreement. In particular, as the guarantor has the benefit of certain rights, such as the right to indemnity from the debtor (business), then any conduct by the bank that actually or potentially prejudices these rights can operate to discharge all of the guarantor’s liability. There follow some examples of the more usual scenarios:

• The bank releases the debtor or gives the debtor time to pay

The ground upon which the guarantor is discharged in both cases is that the guarantor’s right at any time to pay the debt and sue the principal in the name of the creditor is interfered with. In practice, standard bank guarantees will often contain provisions attempting to exclude this rule, but clear language is required.

Even when a variation in the creditor/debtor agreement does not release the guarantor, it may still be the case on the facts that the guarantee becomes ineffective as a way of enforcing payment. In Investec Bank v Zulman [2010] EWCA Civ 536, the amounts owed to a bank by a confectionary company were reduced by an agreement involving the use of a previous deposit to write off some of the debt. However, no agreement to vary the guarantee was ever signed. The original guarantee precluded liability as long as the company’s indebtedness did not surpass £2 million, which in practice made the guarantee worthless to the bank once the debt had been reduced. Nonetheless, the court refused to artificially recognise a revised guarantee.

• There is an increase in the underlying loan

In the case of Triodos Bank NV v Dobbs [2005] EWCA Civ 630, the bank guarantee specifically contained a provision allowing the bank, “without reference to the guarantor”, to “agree to any amendment, variation, waiver or release in respect of an obligation of the company under the loan agreements”. The initial loan to the debtor was later increased substantially, following the original signature of a facility limited to £50,000. It was held by the court that the revision was so far outside the scope of the original facility that it effectively amounted to a new loan that was not covered by the guarantee. The guarantor successfully defended the bank’s claim and the court held that the guarantor was discharged.

Chadwick LJ stated that “the guarantor is not to be taken to have agreed that his liability under the guarantee would be increased or made more onerous by a subsequent agreement made between the lender and the borrower (to which he is not party) unless there are clear words in the guarantee which show that he did agree to be bound to a more onerous obligation in the future imposed without further reference to him”.

CIMC Raffles v Schahin [2013] EWCA Civ 644 even suggested that there may in fact be two (closely related) doctrines at play. One is a matter of pure construction, where a guarantor must have clearly consented to variations in order for the guarantee to stand following those variations. The other is a principle of law “reflecting … equitable concerns” – in other words, to protect guarantors from abusive alterations to the underlying loan.

In certain cases the guarantee will not be totally discharged but there will be a defence to any claim against the guarantor for additional sums lent ( Wittman (UK) Ltd v Willdav Engineering S.A. [2007] EWCA Civ 824).

• Material change in the risk being guaranteed

In general, any type of conduct by a lender or creditor can have the effect of materially changing the balance of the risk that the guarantor had agreed to cover.

Holme v Brunskill (1878) 3 QBD 495 is the origin of the rule that variations in the creditor/debtor agreement discharge the guarantor; a change in the agreement can cause a change in the risk, with the guarantor never having agreed to guarantee the new risk. The judgment of Cotton LJ explains this rationale: “If there is any agreement between the principals with reference to the contract guaranteed, the surety ought to be consulted, and that if he has not consented to the alteration … he will be discharged.” In North Shore v Anstead Holdings (see above), it was established that alterations to the underlying agreement are a matter of objective fact; the court held that a variation had been made, even though both parties to the agreement gave evidence to the contrary.

Essentially, any fact or matter that is likely to increase the risk of default by the principal represents a material alteration of risk, so all matters need to be considered.

It is more common now than ever before for a guarantor to receive the unwelcome news from the bank that the guarantee is being called. The conduct of the bank and the wording of the suite of bank lending and security documents will be key in determining the rights the bank actually has as a matter of law. A careful reading of the documents is the first step a guarantor should take on hearing that a guarantee is being called, but even that will not be conclusive and valid arguments could well be available to guarantors to defend their assets from the reach of the bank.

Some of these arguments about contracts of suretyship that can be raised by a guarantor are very complex and this is especially so where there is more than one guarantor of the same liability. There are even certain situations where a debtor or guarantor can challenge the creditor/debtor agreement on the grounds that it creates an unfair relationship between the two parties. In specific circumstances, the court can effectively rewrite the underlying agreement under the terms of the Consumer Credit Act 1974; this may have the effect of wholly or partly relieving the guarantor.

The key factor is that those on whom such demands are made need to act quickly and obtain competent specialist professional advice at an early stage in order to ensure that legitimate substantive defences are not overlooked.

For more information on unfair relationships and guarantees, please see Patrick’s recent article: Can business guarantees be subject to the Consumer Credit Act tests of fairness?

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Personal Guarantee Commercial Lease

Jump to section.

A personal guarantee commercial lease is a legally abiding contract that makes a business owner assume personal liability for responsibilities and obligations. An individual who signs a personal guarantee acknowledges that, even if the company breaches the lease, they will still be held personally liable. Read this blog further to understand more about personal guarantee commercial lease.

Essential Elements of a Personal Guarantee Commercial Lease

The following are the key elements of a personal guarantee commercial lease:

• Identification of Parties: The names of all the parties to the lease, including the tenant, landlord, and the individual providing the personal guarantee, shall be outlined in the lease.
• Personal Guarantee Clause: Make it plain and unambiguous that the individual supplying the guarantee accepts responsibility for the tenant's obligations and responsibilities as outlined in the lease agreement .
• Scope of Guarantee: Describe the duties and liabilities covered by the personal guarantee, including any financial commitments mentioned in the lease, such as rent payments, additional fees, property damage, maintenance costs, etc.
• Limitations on Guarantee: Consider limiting the personal guarantee, including capping the obligation amount or stating how long the guarantee will last. It can lessen the risks and safeguard the guarantor 's private assets.
• Joint or Several Liability: Determine whether the personal guarantee is joint or several, in which case each guarantor is individually and jointly responsible for the full scope of the tenant's duties. When numerous people are offering personal guarantees, this is vital.
• Notice Requirements: Specify any notification conditions the landlord must satisfy to invoke the personal guarantee. It can entail giving the guarantor written notice when the renter defaults or fails to fulfill the lease terms .
• Release or Termination: Indicate the conditions under which the personal guarantee may be released or canceled, such as upon the assignment or subletting of the lease or the tenant's satisfaction with specific requirements.
• Indemnification: Include provisions requiring the renter to defend and indemnify the guarantor against any losses, costs, or damages incurred due to the tenant's actions or breach of the lease terms.
• Governing Law : Specify the country and legal system that will control the lease and the personal guarantee. It makes it easier to decide which rules and regulations control how the agreement is interpreted and applied.
• Severability: Include a severability language declaring that the remaining terms of the personal guarantee leasing agreement will continue in force if any provision is found to be unenforceable or illegal.
• Amendments: Describe the process for amending the personal guarantee, including the need for written consent from all parties involved, in this section.
• Signature and Date: Ensure that the personal guarantee lease agreement is signed and dated by all parties, including the guarantor, tenant, and landlord, to show that they have read, agree to, and understand its contents.

Risks Involved in a Personal Guarantee Commercial Lease

There are certain risks that individuals need to be aware of before entering a personal guarantee commercial lease, which is:

• Personal Liability: As stated in the lease, the risk of providing a personal guarantee is that you could be held personally responsible for the tenant's debts and other commitments. The landlord may file a lawsuit against you personally to recoup those expenses if the renter breaches other lease clauses, like failing to pay rent on time, causing damage to the property, or meeting other responsibilities.
• Financial Consequences: If the tenant breaks its lease duties and the landlord successfully sues you, you could be held financially responsible for paying a sizable sum, including unpaid rent, late fees, damages, legal fees, and other charges associated with the lease. It could have a significant negative financial impact on your credit score .
• Business Failure: The tenant might be unable to fulfill its responsibilities under the lease if its business fails or runs into financial trouble. In such circumstances, even if the business cannot do so, you would be liable for meeting those commitments as the guarantor. This risk is especially important if you provide a long-term lease with a personal guarantee.
• Difficulty Termination of the Guarantee: Personal guarantees are frequently written to last for the lease term or a predetermined time. It can be difficult to end the guarantee, and you might need to negotiate with the landlord or fulfill certain requirements. Thus, even if you choose to breach the lease, you risk remaining personally liable.
• Joint and Several Liability : Several people may occasionally furnish a personal guarantee for the same lease. If this is the case, the guarantee might be joint and many, which would make each guarantor fully liable for the tenant's obligations. The other guarantors may be obliged to pay the full sum if one guarantor cannot satisfy their responsibility.
• Limited Protection for Guarantors: Guarantors may have limited legal rights, in contrast to tenants, depending on the situation.
• Indirect Impact on Business Operations: A personal guarantee can indirectly negatively impact business operations because it can take time and money away from the business's essential functions and expansion, which could be detrimental to its success.

Primary Considerations in a Personal Guarantee Commercial Lease

Important factors to consider while negotiating a personal guarantee commercial lease are mentioned below.

• Understand Your Position and Risk Tolerance. Make a comprehensive assessment of your position and risk tolerance before entering discussions. Take into account elements, including the creditworthiness of your company, its financial stability, and the potential effects of personal guilt.
• Analyze the Landlord's POV. Understanding the landlord's point of view is essential for successful negotiation. Landlords frequently want personal guarantees to reduce risks and guarantee the lease terms are met.
• Cap the Guarantee Amount. Negotiate a limit or restriction on the personal guarantee amount. It might safeguard your private assets by capping your obligation at a certain amount. For the sake of finding a trustworthy tenant, landlords might agree to this.
• Offer Increased Security Deposit. Suggest a bigger security deposit in exchange for lowering or doing away with the personal guarantee. It shows the landlord you're serious about keeping your end of the bargain and gives them more assurance about your ability to pay.
• Formalize the Negotiated Terms. Make sure that the lease agreement explicitly states the parameters of personal guarantees that were agreed upon following the conclusion of talks. It avoids misconceptions and gives enforcement a legal foundation.
• Recommend a Performance Review. Suggest regular performance reviews to gauge the company's financial stability and reevaluate whether the personal guarantee is still necessary. You can agree to have the personal guarantee released or changed if the company exhibits consistent financial stability or satisfies certain requirements.

Key Terms for Personal Guarantee Commercial Leases

• Personal Guarantee: The individual accepts that they will be accountable for independently upholding the lease's requirements.
• Liability: The individual offering the personal guarantee is potentially responsible if tenants fail to legally and financially fulfill their obligation.
• Obligation: Duty, responsibility, or commitment to carry out a particular activity or satisfy a particular condition.
• Financial Responsibility: The responsibility and accountability for the monetary elements of a specific circumstance or agreement.
• Termination: The action of terminating or canceling the lease before the lease's expiration date.

Final Thoughts on Personal Guarantee Commercial Leases

A personal guarantee commercial lease is a big commitment that affects the guarantor's finances and legal standing. Tenants can safeguard their private assets and reduce prospective liabilities by assessing their financial situation, negotiating the extent and duration of the guarantee, looking into other security solutions, and getting legal counsel. Tenants can confidently manage personal guarantees in commercial leases and safeguard their financial security by making well-informed decisions and taking proactive measures to reduce risks.

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Ryan A. Webber focuses his practice primarily on Estate Planning, Elder Law, and Life Care Planning. His clients range from young families concerned about protecting their family as well as aging individuals. Ryan provides Estate Planning, Trust Planning, Special Needs Planning, Public Benefit Planning, and Estate Administration. Ryan focuses on the holistic approach to the practice of elder law which seeks to ensure clients are receiving good care when needed and that they preserve enough assets with which to pay for such care. Many families and individuals also come to Ryan for preparation of their wills, power of attorney, and healthcare guidance documents. Additionally, Ryan assists small and medium sized business owners with their organizational and planning needs. From starting or winding down a business, Ryan provides quality business advice.

Skilled in the details of complex corporate transactions, I have 15 years experience working with entrepreneurs and businesses to plan and grow for the future. Clients trust me because of the practical guided advice I provide. No deal is too small or complex for me to handle.

Agnes Mombrun Geter is the Founder and Managing Attorney of Mombrun Law, PLLC. She is an experienced attorney and is a member of the Florida Bar, New Jersey Bar, and the Pennsylvania Bar. The firm's practice focuses on Estate Planning, Business Law, and Debt Settlement including IRS Debt Relief. The firm's goal is to simplify the law and provide clients with the confidence and information necessary to make their decisions. The firm also provides project-based legal services to other attorneys and law firms, along with assisting as personal counsel and local counsel on legal matters.

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Tiffanie Wilson is a business transactions and personal injury lawyer. She helps clients realize their business goals by expertly drafting contracts, providing sound legal advice, and working for justice for injured clients.

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Be Careful When You Personally Guarantee a Contract

HNW May 3, 2021 Business Law , Contract Law

A contractual guarantee agreement means if a contract is breached and payment not made, the person who guaranteed the contract can be held personally liable for payment to the other side.  The rules governing the interpretation of a personal guarantee agreement have not changed much over the years.  These same rules govern question(s) relating to the interpretation of a contractual guaranty.

Don’t forget, if a contract and its express language contains a personal guarantee clause, you’re on the hook.

To discuss your NJ business contract, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at [email protected] .  Please ask us about our video conferencing consultations if you are unable to come to our office.

By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold Township, Monmouth County, NJ Business Law Attorney

Absolute and Unconditional Guarantees Under New York Law

The Metropolitan Corporate Counsel

The article addresses New York federal court decisions that complicate the drafting of an absolute and unconditional guarantee from a third party in commercial transactions. The article also provides guidance in drafting guarantees that are more likely to be enforced by the courts, including, among other things, the ​ “ absolute and unconditional” statement, a waiver of all defenses, and avoidance of certain representations.

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Personal Guarantee: Definition and Role in Loan Requirements

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

Katrina Ávila Munichiello is an experienced editor, writer, fact-checker, and proofreader with more than fourteen years of experience working with print and online publications.

What Is a Personal Guarantee?

The term personal guarantee refers to an individual’s legal promise to repay credit issued to a business for which they serve as an executive or partner. Providing a personal guarantee means that if the business becomes unable to repay the debt , the individual assumes personal responsibility for the balance. Personal guarantees provide an extra level of protection to credit issuers who want to make sure they will be repaid.

Key Takeaways

• A personal guarantee is an individual’s legal promise to repay credit issued to a business for which they serve as an executive or partner. 
• Personal guarantees help businesses get credit when they aren't as established or have an inadequate credit history to qualify on their own.
• Enforcing personal guarantees also mitigates the risk to creditors since they have a legal claim to an individual's assets.
• Business owners should read the terms and conditions of any credit application carefully for language that highlights personal liability.

How Personal Guarantees Work

Personal guarantees are used in credit deals to secure funding for businesses. They are used by new and small businesses —generally, for companies that may not be as established or for those with inadequate credit history to qualify for loans and other credit on their own. When a personal guarantee is given, the principals of the company pledge their own assets and agree to repay a debt from personal capital in case the company defaults. In short, the business owner or principal becomes a cosigner on the credit application.

Here's how it works. Lenders may require business owners or executives to provide a personal guarantee in order to access credit if the company is too new or has a bad credit history. The business principal includes their own credit history and profile as part of the credit application which forms the primary basis for underwriting. When a personal guarantee is used, the applicant includes their Social Security Number (SSN) for a hard credit inquiry as well as details about the individual’s personal income. This information is in addition to the company's employer identification number (EIN) and financial statements.

An executive may also pledge their own personal assets —checking accounts, savings accounts, cars, and real estate—and agree to repay a debt from personal capital in case the company defaults as part of their personal guarantee. Not only does this make credit more accessible to businesses, but it also mitigates the risk to creditors since they have a legal claim to the individual's personal assets. It also improves the terms which will be based on the profile of both the business and the individual in the underwriting process.

Small business owners and executives normally make a substantial initial investment using their own capital . That's one of the reasons why they offer personal guarantees to get credit—because they have a vested interest in the launch and development of their businesses. As such, businesses may be required to pay creditors monthly installment payments rather than generating a return for equity investors.

Special Considerations

Although well-established businesses with significant commercial credit profiles may be able to obtain credit without a personal guarantee, they may still use them in their applications. Credit with a personal guarantee can be a low-cost way for a business to obtain funds. But if the business isn't able to generate enough revenue and earnings, an individual could suffer significant losses. Remember, if a personal guarantee is used, the principal is personally liable if a default occurs. It gives creditors a legal right to all of an individual's pledged personal assets.

The New York Times report on former President Trump's taxes indicates that he took this route, personally guaranteeing "loans and other debts totaling $421 million" by 2018.   This provided a benefit, as well—taking responsibility enables a business owner to use those losses to offset current and future taxes they owe.

Having said this, business owners should be especially careful when they apply for credit as terms may require a personal guarantee. Applicants should look for language in the credit application such as “you, as an individual and the authorizing officer of the company...are agreeing to be jointly and severally liable with the company for all charges to the account.”

Many private lenders require personal guarantees before they advance any credit to certain types of businesses. What many people may not realize is that the Small Business Administration (SBA) also requires principals to offer personal guarantees in order to get an SBA loan. Anyone with an interest in a business of 20% or more must provide the SBA with an unconditional personal guarantee. These loans are backed by the SBA but are issued by the administration's lending partners .

The Small Business Administration requires a personal guarantee from anyone with an interest of 20% or more in a company.

Types of Personal Guarantees

There are two common types of personal guarantees—limited and unlimited. Limited guarantees allow lenders to collect a certain amount of money or a certain percentage of the outstanding balance from a principal or business owner. These guarantees are common when there are multiple principals who can pay a certain portion of the debt. For instance, if a business defaults on its loan, the lender can go after each principal for 25% of the balance.

Unlimited guarantees, however, require that the principal is liable for the full outstanding balance. Personal guarantees required by the SBA are considered unlimited guarantees. So if a business can't fulfill its obligations on a loan with a personal guarantee, the lender can go after the principal to recoup the full outstanding balance. If there aren't enough liquid assets available—through checking and other, similar accounts—the lender can seize other assets such as real estate or vehicles.

New York Times. " Long-Concealed Records Show Trump's Chronic Losses and Years of Tax Avoidance ." Accessed Feb. 4, 2021.

SBA. " Unconditional Guarantee ." Accessed Jan. 29, 2020.

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We connect people and ideas, what is a personal guarantee.

A personal guarantee is a promise made by a guarantor that they will personally meet the obligations of another person or company if that person or company defaults to the creditor under the original, or primary, agreement.

In other words, Party A and Party B have made an agreement. This is the original agreement. The guarantor is then making a promise to Party B that it will personally fulfil Party A’s obligations under the original agreement if Party A fails to fulfil them. This is the secondary agreement.

Personal guarantees are a useful tool to supplement a credit agreement. However, there are several critical points that if missed, can prove fatal to enforcing a guarantee.

why seek a personal guarantee

Personal guarantees are commonly used by creditors to ensure that directors and owners are personally responsible for their companies’ debts. Guarantees in these circumstances are particularly useful where the company is at risk of insolvency. This is a way to ‘pierce the corporate veil’, and avoid falling victim to illegal phoenix activity, where directors set up a new company to continue the business of a liquidated company in order to avoid paying outstanding debts.

Guarantees can also add an extra level of security to ensure that services or goods are received as promised, or that other contractual obligations are performed. The promise made does not have to be restricted to a financial guarantee, it is simply a promise to fulfil the obligations of the original agreement.

what should be in a guarantee

• Clear wording

There is no “one-size-fits-all” when it comes to personal guarantees. While there are elements which need to be satisfied for the guarantee to be valid, the parties are free to include a variety of different terms depending on the desired effect and agreed arrangement.

For example, guarantees can:

• limit the level of obligations of the guarantor;
• cap the monetary obligation to a specific amount;
• limit the time for which the obligations exist; or
• specify particular notice periods.

It is essential that the wording of a guarantee accurately reflects what is intended by the parties. Without clear drafting, a guarantee may be unenforceable. For example, unless a personal guarantee expressly states that it is irrevocable, it may be able to be withdrawn by the guarantor at any time. Another example of the importance of wording is that unless a guarantee states that it is for “all monies”, it may be limited to present debts, and may not include any future debts.

Ultimately, guarantees can include any terms which are agreed by the parties and should contain wording that is clear and easily understood.

• Essential elements

Beyond wording, there are essential elements to personal guarantees which must exist to ensure that it is valid and binding. Personal guarantees must:

• be in writing;
• be executed by all the relevant parties; and
• be executed correctly.
•  Appropriate execution clauses

A personal guarantee can be made in any form, however the form chosen will dictate the required execution clauses. For example, a deed must be “signed, sealed and delivered”. This means that it must include the company seal and be delivered to the other party. A deed executed by an individual must clearly include the names and signatures of the signatory. A witness is also required to execute a deed signed by an individual.

The elements of offer, acceptance, intention to be bound by law and consideration must be satisfied.

This also slightly varies depending on the form of the agreement. Personal guarantees are often written in the form of a deed because deeds do not require consideration. This means that there does not have to be an exchange of something of value for the arrangement to be binding. As personal guarantees rarely give a benefit to the guarantor, a deed is a common choice for form of guarantees.

The usual contract law and equity doctrines such as privity of contract, capacity, certainty, undue influence and unconscionable bargaining also apply.

charging clauses

A personal guarantee can take many forms. It could be a simple guarantee, in the sense that it is a promise to fulfil the financial obligations to repay the debt of another person/company in the event that they default. However, it could also include a charging clause, where the guarantor nominates specific assets as security in the event of non-payment.

Where a personal guarantee includes a charging clause over real property, the creditor is entitled to lodge a caveat over land owned by the guarantor. This acts as a notice to other creditors that the creditor has a secured interest in the property. An appropriately worded charging clause prevents the guarantor from selling or transferring ownership of their charged real property without the creditor’s knowledge.

carruthers clauses

One issue that creditors may run into is when they have received payment from the original debtor under the original agreement, and the debtor subsequently goes into liquidation. Payment of a guaranteed debt automatically discharges a guarantor from all liability. If, however, that payment is later set aside and clawed back as an unfair preference by the liquidator, the guarantor remains discharged from liability despite the debt continuing to exist.

To avoid such a scenario, guarantees can include a clause which states that any payments made to the creditor which are later avoided by application of statute will not release the guarantor from liability. This type of provision is known as a Carruthers’ clause , and has the effect of reviving the liability of the guarantor in situations where the debt has been discharged but later reinstated.

common problems with personal guarantees

• Strict interpretation  

Because signatories to a personal guarantee are bound by the wording of the guarantee as signed, care must be taken when drafting and reviewing personal guarantees.

You need to be sure that all relevant terms are included, and all relevant parties are named and have validly executed the guarantee. You should also ensure that any future alterations to either the original agreement or the guarantee are done in writing and signed. Variations to the original agreement may have the effect of creating a new agreement that is not subject to the guarantee.

While a court may consider the factual circumstances surrounding the creation of the guarantee, it is important that the written agreement accurately reflects the intention of the parties. A properly drafted agreement with clear and unambiguous language will always assist in the contract being interpreted as intended.

• Guarantor’s capacity to fulfil their obligations

As a creditor it is important to ensure that the guarantor has sufficient assets in their own name in the event the guarantee is called upon. There is no point in having an air-tight personal guarantee signed if the guarantor is not in a financial position to be able to repay the debts of the original agreement.

To avoid surprises, it is best practice to take due diligence steps by conducting title searches and other background checks on the guarantor prior to signing.

how macpherson kelley can help

Personal guarantees are a useful tool to supplement a credit agreement, however a lawyer with experience in the area can identify potential risks that may plague the enforcement of a guarantee if ignored or overlooked.

Contact Macpherson Kelley’s team to receive expert advice.

A version of this article was originally published in CreditorWatch.

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India: Is A Personal Guarantee Independent Of The Underlying Debt?

Introduction.

Personal guarantees are one of the most common contractual comforts which may be provided as part of the security package in a transaction to secure a debt availed by the principal debtor. This article primarily revolves around the invocation of a personal guarantee provided by an individual, for a company undergoing the corporate insolvency resolution process (" CIRP ") under the provisions of the Insolvency and Bankruptcy Code, 2016 (" IBC ") initiated by its creditors and having a third-party resolution applicant taking over the management and control of the company.

Recently, the Hon'ble Debts Recovery Tribunal bench at Ahmedabad (" DRT ") vide its order dated 11th of March, 2022 1 (" Order ") dismissed the original application (" Original Application " / " OA ") filed by various banks and stakeholders led by the State Bank of India (" Applicants " / " Applicant Banks ") against Mr. Prashant Ruia (the " Defendant No. 1 ") and other defendants (hereinafter collectively referred to as the " Defendants "). The said Order mainly deals with determining the existence of debt as defined under Section 2 (g) of The Recovery of Debts and Bankruptcy Act, 1993 (" RDB Act ") subsequent to the assignment of the same for a valuable consideration under a resolution plan and the consequent validity of the invocation of a personal guarantee provided as a part of the original security package for the Debt.

The primary facts and issue of the case are laid out hereunder:

• The Defendant No.1 and other promoters had executed various personal guarantees (" Personal Guarantees ") to ensure repayment of amounts due and payable by Essar Steel India Limited (now known as ArcelorMittal Nippon Steel Limited) (" Principal Borrower ") under various credit / financial facilities (" Debt ") availed by the Principal Borrower from the Applicant Banks.
• The Principal Borrower underwent CIRP pursuant to which the National Law Tribunal, Ahmedabad bench (" NCLT ") approved the resolution plan of Arcelor Mittal India Private Limited (the " Resolution Applicant ") under Section 31 of IBC on 08th March, 2019 which was thereafter also confirmed by the Hon'ble Supreme Court on 15th November, 2019 2 . In terms of the said resolution plan, the creditors including the Applicant Banks had assigned the Debt (excluding the Personal Guarantees) to the Resolution Applicant.
• The Applicant Banks contended that the liability of the Defendants subsists and continues even after the approval and implementation of the resolution plan under IBC. Moreover, since the liability of the Defendants is under a separate contract of personal guarantee, their liability subsists. The Applicant banks also stressed on the fact that under the assignment agreement, the Personal Guarantees had not been assigned to the Resolution Applicant and therefore the Applicant Banks were deemed to have retained their recovery rights towards the unrecovered interest portion of the Debt from the Defendants.
• The main issue before the DRT was whether having assigned the "debt" as defined u/s 2 (g) of the RDB Act, for valuable consideration, as part of the resolution plan under IBC, did the Applicant Banks have any recourse and recovery rights against the Defendants?

The Hon'ble DRT perused the assignment agreement executed by the financial creditors of the Principal Borrower in favour of the Resolution Applicant. It observed that according to the provisions as laid out in the assignment agreement, the assignors (including the Applicant Banks) agreed to unconditionally and irrevocable transfer, sell, assign and release to the assignee (being the Resolution Applicant itself in this case) on an "as is, where is", "as is, what is" and "without recourse" basis all the loans of the Principal Borrower albeit excluding the guarantees made in connection with the said loans.

The Hon'ble DRT stated that legal effect of an assignment is that the Debt as a whole stands entirely discharged upon receipt of the amounts under the resolution plan by the Applicant Banks. If the Applicant Banks have no amounts due to be recovered from the Principal Borrower, the Defendants too stand to be discharged from the obligation of fulfilling their liabilities in spite of the fact that the Personal Guarantees have been retained and specifically excluded in the resolution plan and the assignment agreement.

Further, placing due reliance and importance to the resolution plan, the Hon'ble DRT took cognizance of the provisions of the resolution plan, wherein it was stated that the payments made to the financial creditors would be treated as full and final payment of the entire outstanding dues. The provisions of the resolution plan also stated that all claims along with any related proceedings, including proceedings for enforcement of any security interest pertaining to the Principal Borrower shall stand extinguished, settled, abated and satisfied. Even on perusal of the deed of guarantee(s) executed by the Defendants with reference to the provisions of the resolution plan formulated for the Principal Borrower, the Hon'ble DRT stated that on a conjoint reading of both, the invariable conclusion was that the Debt of the Principal Borrower due to its financial creditors stood fully and finally satisfied.

In light of the aforementioned, the Hon'ble DRT dismissed the OA on account of there being no cause of action for any recovery post the assignment becoming infructuous.

The Order provides perspective on the position of law on guarantee invocations vis-à-vis existence of debt in cases where debts have been assigned. The Supreme Court has of course in various judgments held that an involuntary act of the principal debtor would not absolve the guarantor of its liability and the sanction of a resolution plan does not automatically operate as a discharge of the guarantor's liability.

In this case however, there was a situation where the Debt secured by the Personal Guarantee was satisfied vis-à-vis the Applicant Bank but remained due and owing to the resolution applicant. The Personal Guarantee however was not so assigned and continued to operate in favour of the Applicant Bank. In effect, the singular Debt owed by both the Principal Borrower and the guarantors to the Applicant Bank would operate as two debts - one owed by the Principal Borrower to the resolution applicant in view of the assignment of that Debt; and the second, owed by the guarantors to the Applicant Bank under the guarantees which were not so assigned. It appears that in view thereof the DRT has held that there remains no underlying debt due to the Applicant Bank in its books from the Principal Borrower as the same was assigned and therefore the Applicant Bank cannot in law trigger the Personal Guarantees.

While this Order does clarify the position that assigning the benefit of guaranteed debt while retaining the benefit (and a right of invocation) of the guarantee itself is not enforceable, it does not as such deviate from the position adopted by the Supreme Court that what determines the liability of a guarantor would depend in each case on the terms of the guarantee, the resolution plan and the facts of the matter at hand and the sanction of a resolution plan does not, as a matter of course, discharge the guarantors of their liabilities even if the debt due from the corporate debtor is settled.

1. IA No. 92 of 2022 in OA No. 650 of 2018

2. (2020) 8SCC531

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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If Secured Financial Creditors have assigned their entire debt from the Borrower to the Successful Resolution Applicant under a Resolution Plan, they cannot invoke the Personal Guarantees after approval of the Resolution Plan – State Bank of India Vs. Mr. Prashant S. Ruia – DRT Ahmedabad Bench (DRT-1)

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