What is a Personal Guarantee?
A personal guarantee is a significant commitment that can have legal and financial ramifications for business owners. Creditors usually employ these documents and can include lenders, landlords, and various business partners. These documents offer safeguards when the principal debtor, typically a corporate entity, fails to fulfill its payment obligations.
In business borrowing, financial institutions frequently request a personal guarantee as a prerequisite for providing funds. This arrangement empowers the bank to pursue repayment from other individuals with their personal assets if the business entity defaults on its obligations. This means that the individual’s personal assets, such as property, savings, and investments, can be used as collateral to secure the loan.
Personal guarantees are a safety net for lenders, especially when dealing with small businesses or startups lacking an extensive credit history or valuable assets. By requiring a personal guarantee, lenders seek assurance that they will be repaid even if the business faces financial difficulties.
However, for business owners, providing a personal guarantee comes with several legal and financial implications:
- Personal Liability: Signing a personal guarantee means that if the business defaults on the loan, the individual becomes personally liable for the outstanding amount, including interest and fees.
- Risk to Personal Assets: The most significant consequence of a personal guarantee is that the individual’s personal assets are at risk. This can include homes, vehicles, savings accounts, and other valuable possessions that the lender can seize to recover the debt.
- Credit Impact: A loan default associated with a personal guarantee can hurt the individual’s personal credit score, affecting their ability to secure financing in the future.
- Legal Action: If the business defaults, lenders have the legal right to pursue legal action against the individual to recover the debt, potentially leading to wage garnishment or other enforcement measures.
What to Consider
Given the potential consequences of a personal guarantee, if you are a business owner, it might be crucial for you to carefully assess the situation before committing:
Financial Health of the Business: Evaluating the business’s financial stability and ability to repay the loan is an important consideration. A personal guarantee might be more palatable if the business has a strong track record and a solid repayment plan.
Negotiation: When dealing with lenders, it is worth discussing whether a personal guarantee is negotiable. Some lenders or landlords might be open to alternative forms of collateral or security.
Legal Counsel: Seeking legal advice is essential before signing any legal agreement, including a personal guarantee. An attorney can help you understand the terms, potential risks, and implications of a personal guarantee you must sign to obtain a business loan.
Limiting Exposure: If a personal guarantee is inevitable, you might wish to explore ways to limit the extent of your exposure. These alternatives might involve considering co-guarantors.
It’s important to understand that a personal guarantee creates a legally enforceable obligation. If the primary debtor defaults, the guarantor can be held responsible for repaying the debt, including any associated interest, fees, or costs. This means the guarantor’s personal assets could be at risk if they cannot fulfill the obligations outlined in the guarantee.
Summary
Before entering into a personal guarantee, whether as a guarantor or a debtor, it’s crucial to carefully review the terms of the agreement and seek legal advice if needed. Guarantors should fully understand the potential financial risks and consequences before agreeing to provide a personal guarantee for another party’s obligations.
If you are seeking independent legal advice from a Toronto Business lawyer contact us today to book a consultation.
