HOW BUSINESS PEOPLE CAN AVOID PERSONAL GUARANTEES. AND HOW TO MINIMISE PERSONAL GUARANTEE RISKS. By Atticus Legal, Wizard-like Company Lawyers Hamilton & Business Lawyers Hamilton
A recent article on the above subject emailed out by the Ministry of Business Innovation & Employment (MBIE) suggested three ways to protect yourself when you are asked for a personal guarantee from a business supplier (ie. other than your bank). We agree with some of those suggestions, but we have others as well. Below are some useful tips on how to avoid signing personal guarantees ‘required’ by your suppliers. And how to limit the potential fall-out if you do sign guarantees.
The MBIE suggestions were:
- Show that the guarantee isn’t necessary. That is, try to convince the supplier that you have a strong credit history and that on that basis a personal guarantee should not be required. Don’t hold your breath on this one.
- Negotiate the terms of the guarantee (eg. to limit the period of the guarantee to 2 or 3 years during which you can prove your reliability). Again, don’t hold your breath. A supplier is unlikely to agree this.
- Put your home and major assets into a family trust. Agreed. See below.
This article focuses on personal guarantees required by business suppliers to your company. You will almost never be able to avoid giving personal guarantees to the company’s bank and to the landlord of premises that your company leases. Both the bank and the landlord will require guarantees from the directors and (the majority, if not all) shareholders. That’s a commercial fact of life.
Tips to avoid personal guarantees or reduce liability on a personal guarantee
But in the case of the lease personal guarantee you can limit your guarantee exposure by negotiating a lease with a relatively short term and short renewal terms – eg. a 2 year term with 4 rights of renewal of 2 years each, rather than a 5 year term with one renewal term of 5 years. Why? Your personal guarantee extends for the entire term or renewed term, as the case may be. The shorter the term, the less the guarantee exposure if you can’t find another tenant to replace you.
Other ways to avoid or reduce personal guarantee liability:
- Consider offering a direct debit authority to your regular major suppliers, in return for your supplier waiving the guarantee requirement. Suppliers want personal guarantees when they provide ‘credit’ to your company (even normal credit terms such as payment on the 20th of the following month). Your supplier may accept that there is little or no ‘credit risk’ if you have put in place a direct debit.
- When your supplier sends you their terms of trade and ‘credit application’ for signing, read through them carefully and delete any personal guarantee clause before you sign. Often the guarantee is worded such that whoever signs these documents on behalf of the company will be a guarantor. Return the amended signed documents and see what happens. Sometimes the supplier will continue to supply you anyway.
- Alternatively, try not signing and returning the ‘credit application’ and continue to place orders. Maybe you’ll get away with it, although ‘heavy-weight’ suppliers (eg. Bunnings) will always insist on signing of their documentation. But the point is, if you can at least reduce the number of personal guarantees you give out, that’s better than nothing.
- Consider not having your spouse/partner as a director of the company. Credit suppliers sometimes want guarantees from all the directors.
- If your company is not wholly owned by you and your spouse/partner (ie. others hold shares as well), don’t be the one that always signs guarantees for the company. If required, others who have a stake in the company should sign guarantees as well. In this case you should have in place either a signed shareholders agreement or deed of contribution with an appropriately-worded clause whereby all shareholders indemnify any guaranteeing person in proportion to their shareholdings. Such a right of indemnity from other shareholders is not automatic. It needs to form part of a binding signed agreement specifically addressing it.
- Don’t treat a credit supply arrangement like a credit card and make purchases up to the credit limit ‘because you can’. Chickens eventually come home to roost.
- Consider putting in place a family trust to hold your home and other major assets and thereby have them protected from business creditors and personal guarantee liability.
Provided those assets are transferred into a trust before creditor claims or liability has arisen and without the intention of ‘defrauding’ creditors, those assets can be protected from such claims. This also requires that you are ‘solvent’ at the time you transfer assets to the trust.
If you are thinking of starting/buying a business and taking on a lease, consider putting in place the family trust (and transferring assets to it) soon after the lease, or assigned lease, has been entered into by your company. On a lease assignment the landlord will want details of your personal assets and liabilities (including those of any trust) as a condition of consent to the lease transfer to your company. If you don’t have a trust at that time you will disclose those assets and liabilities in your own name and no doubt the landlord will require your personal guarantee. But if you later transfer assets to a trust you have no obligation to tell the landlord that (or any other suppliers on credit).
Remember that the ‘creditor protection’ offered by a family trust is protection of the assets it holds. It does not protect you from being sued on personal guarantees, etc. If your business does fail and you are sued on personal guarantees you have signed and you have your major assets in a trust you will need to make a decision:
- Do I arrange for my trust to bail me out? – eg. if you have judgment debts against you for a low-to-moderate amount and the trust has the ability to pay those debts (so that you avoid personal bankruptcy); or
- Are you prepared to go into bankruptcy (with the trust retaining the family home, etc)? – this may be the case especially if your judgment debts are ‘overwhelming’.
So in the above circumstances there is a choice to make – whether or not to retain trust assets or use them to pay creditors. Still, at least you would have that choice. You wouldn’t if the assets remained in your name.
WANT TO KNOW MORE? Just ask Atticus Legal, Supremo Company Lawyers Hamilton & Business Lawyers Hamilton
CALL ANDREW SMITH, the owner of Atticus Legal, for expert professional advice on any of the matters referred to in this information sheet.
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