Personal guarantees serve as a valuable form of security for finance providers when entering into finance agreements.

By incorporating personal guarantees into deals, creditors can enhance their options for recovery and ensure an additional layer of protection against potential default.

Crafting such agreements, whilst complying with legal requirements and including comprehensive provisions is not an easy task. There are a number of important factors for consideration.

Requirements for valid execution of a guarantee

If the guarantee is drafted as a contract, then there is a requirement to evidence consideration (for example “in consideration of providing credit to the borrower”). Parties will however often look to avoid the requirement of consideration by executing the guarantee as a deed.

The essential elements of execution of a deed are that it is signed, witnessed and delivered. The witness should be independent and must be present when the deed is signed. The witness must never be a person who is party to the deed. Traditionally ‘delivered’ meant the handing over of the deed to the person who was taking the benefit however nowthis usually means when the deed is dated and a copy provided to all parties. If the execution process is not carried out properly the deed is unlikely to be valid and effective.

An interesting question surrounding guarantees is the use of electronic signatures and how this impacts the ability to execute a document as a deed. If the guarantee is intended to be signed as a contract, there is little risk involved with obtaining an electronic signature.

However, the risk becomes more apparent when considering if electronic signatures meet the requirements for witnessing a deed. The regulation in this area is not well established and will likely be subject to change as technology continues to advance.  

The primary issue is around whether the document can be witnessed.  The creation of an electronic signature, which connects two pieces of data is not something that can be witnessed easily, but the signatory’s actions in making that connection could be. Due to the lack of a clear legal precedent, the court’s decision could swing in either direction, creating a substantial level of risk for the creditor.  Given the impact technology has already had on the legal industry, this is definitely an area for legal reform.

Is the guarantee an indemnity?

A guarantee is a secondary obligation which secures the obligations of a third party. For a guarantee to crystallise and be called upon the third party must have failed to comply with one or more of the guaranteed obligations (for example not paying back a loan to a lender).

An indemnity is similar to a guarantee and is a contractual promise to accept liability for another party’s loss. Unlike guarantees (which are secondary obligations), indemnities are primary obligations in favour of the beneficiary and exist independently of any obligations of the third party. An indemnity may therefore be enforceable even if the principal party is not in default of its obligations.

Joint and several liabilities

In many instances, creditors will obtain guarantees from multiple individuals, usually the directors of a debtor company, to provide extra protection in the event of a breach. However, issues can arise when there is a lack of clarity on how much liability each guarantor has.

If the party’s obligations are made clear at inception, then there is no room for argument and the creditor puts themselves in a much better position. The best way to do this ensure the guarantors are jointly and severally liable, meaning the guarantors have ‘jointly’ made the same promise to the beneficiary, but also individually made the same promise to the relevant person.

Misrepresentation

The terms and provisions of any agreement are extremely important; however, creditors should not overlook the significance of transparency and misrepresentation during the creation of the agreement.

If a creditor willingly or unwillingly omits certain facts or details when the contract is being agreed, or the specific conditions of the agreement are not met, the contract can become void, cutting off avenues for recovery. Any terms which a creditor wants to impose on any party to the agreement must be set out clearly at the outset.

What triggers a call on the personal guarantee?

To activate a guarantee, a third party must breach or trigger it. A default of the principal party’s obligations will normally trigger the guarantee, for example, if loan repayments are missed or there is a failure to comply with the conditions of a contract. A creditor is not necessarily obliged to sue the principal party first and is entitled to seek payment from the guarantor of all sums guaranteed that have become due.

Personal guarantees are a strong tool for minimising a creditor’s losses. However, the method of obtaining guarantees should not be taken lightly. By taking careful steps to obtain personal guarantees, you can safeguard your business and ensure your financial security.

At Greenhalgh Kerr, our team of experts are ready to provide guidance whenever needed.

Georgina Hannah