CREDIT INSIGHTS
Personal Guarantees Gone Wrong
A well-executed personal guarantee can be the holy grail of debt recovery tools, but one overlooked detail can bring the whole thing to its knees.
It is surprising the number of clients relying on guarantees that are either ineffectively drafted or have been inadvertently discharged by the actions of the client.
Having recently experienced a number of matters where the complacency of others has resulted in a less favourable outcome for the creditor, we have identified five examples where a little care could have provided a radically different outcome.
A well-executed personal guarantee can be the holy grail of debt recovery tools, but one overlooked detail can bring the whole thing to its knees.
1. GET IT IN WRITING, GET IT EXECUTED AND GET THE ORIGINAL
REAL CASE EXAMPLE:
We recently commenced proceedings under a personal guarantee for a client who was owed several hundred thousand dollars.
What seemed like a straightforward guarantee case quickly became more complicated when the guarantors alleged they had not actually signed the guarantee but, instead, their financial controller had placed electronic versions of their signatures on an execution page and submitted the credit application without their approval.
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Conducting business in the electronic age has revolutionised both the delivery of contractual documents and their execution, with creditors opting to email pro forma agreements and guarantees to customers to save time. However, with a range of facilities available to unscrupulous individuals in the modern workplace, creditors need to be more wary of fraudulently executed guarantees.
It is sufficient to prove that the name (or electronic signature) that has been placed on the document appears to authenticate the contents of the document, unless it can be shown that the person did not cause the signature to appear.
These practices were recognised in 1999 by the Commonwealth when it enacted the Electronic Transactions Act 1999 to give effect to agreements (including guarantees) that are in an electronic format and executed with an electronic signature.
Whether a creditor seeks to enforce a guarantee executed in the traditional pen to paper method or an electronic document, it is important that a creditor ensures that the guarantee has been executed by the guarantor.
It can be particularly hazardous if a creditor is not dealing directly with the guarantors—for example, when negotiating with a regular contact within a company to obtain directors’ guarantees. In these circumstances, creditors should insist that an original copy of the guarantee be provided directly from the guarantors or require the guarantors to execute the guarantee before a witness attesting to the guarantor’s identity.
2. UNLESS ALL INTENDED GUARANTORS SIGN, EVEN THOSE WHO DID MAY BE UNENFORCEABLE
REAL CASE EXAMPLE:
In another recent matter, the personal guarantee attached to the credit agreement specified the name of the three company directors from whom our client sought guarantees. Only two directors signed and returned the documents, and our client made a commercial decision to provide credit notwithstanding.
When recovery proceedings commenced against the two signed guarantors, they defended on the basis that the guarantee was not binding because the third intended guarantor had not executed the document.
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Given the formalities required to ensure the validity of a guarantee, care should obviously be taken to ensure that the written guarantee not only contains all of the relevant terms of the agreement, but also include all relevant parties. Where it is contemplated that a creditor will require guarantees from more than one person, the guarantee will not come into effect until such time as all the intended guarantors have validly executed the guarantee.
A guarantor will be required to show the court it was clearly contemplated that further guarantees must be obtained (as opposed to might be obtained) to avoid being bound by a guarantee. The court will then consider the implicit terms of the guarantee, as well as other evidence—for example, additional documents and verbal negotiations between the parties to decide whether the creditor was obliged to obtain additional guarantors.
To avoid losing the ability to enforce a guarantee for the failure to obtain the execution of all of the intended guarantors, it is essential that a clause is included to state that all of the signatories are bound to the guarantee irrespective of whether the additional guarantors are bound by the guarantee.
3. GUARANTEES INTENDED FOR A GROUP STRUCTURE MUST COVER ALL LEGAL ENTITIES
REAL CASE EXAMPLE:
Some years ago, we acted for a publicly listed client in pursuing a range of claims under its standard form credit agreement and personal guarantee. According to the terms of the document, the company entitled to enforce the credit agreement and personal guarantee was ‘XYZ Holdings Pty Ltd’. Although ‘XYZ Trading Pty Ltd’ was part of the same group of companies, it was not specifically named in the guarantee so powerless to enforce it.
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Working with larger clients with several entities within the same group, it is not surprising to see guarantees being obtained by a head company which are intended to be relied upon by other companies within the group.
What is surprising is the number of times where guarantees for large (sometimes publicly listed) clients do not have guarantees which are drafted in a way which covers all companies within the group.
It is possible for a group structure to rely on ‘all monies’ clauses to cross guarantee obligations across all members of a specified group, on the proviso that the terms of the guarantee expressly provide that the guarantee is to be utilised by the entirety of the group and that the guarantor is aware of the cross guarantee nature of his liability to other members of the group at the time of execution.
A proper description of all of the intended creditors should be a statement that is broad enough to include a clearly recognisable group of entities without necessarily limiting the group by explicitly naming each individual entity.
4. IN DOING A DEAL WITH THE DEBTOR, DON’T DISCHARGE THE GUARANTEE
REAL CASE EXAMPLE:
One of our longstanding clients was owed approximately $50,000 by a company operating a retail store. In exchange for payment of $10,000 and a repayment agreement in respect of the balance, our client agreed to continue supplying goods on credit.
It was only a matter of time before the debtor defaulted under the repayment agreement, but by granting the debtor a payment extension, the creditor unknowingly discharged the terms of the original guarantee, leaving himself unprotected.
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A variation of the principal agreement with the creditor and the debtor may result in the discharge of the guarantee. It is important to take care when negotiating with the principal debtor (particularly when arranging payment arrangements) that the guarantee is not inadvertently discharged by accident.
Circumstances where a guarantee may be discharged by variation of the principal agreement include:
- increasing the potential liability of the principal debtor.
- extending the time for payment of the debt owed to the creditor.
- covenanting to not sue the debtor; or
- discharging the debtor from any further liability under the principal agreement by acceptance of a partial payment of the debt.
To avoid this risk, it is crucial that guarantees include both a ‘principal debtor’ clause and a ‘reservations of rights’ clause, which preserve the creditor’s rights under the guarantee in the event of a variation of the principal agreement or release of the debtor’s liability to the creditor.
5. RISK OF CLAW BACK FROM LIQUIDATOR/TRUSTEE CAN BE LIMITED
After achieving a successful recovery for clients, it is disheartening (to say the least) to see the debtor company subsequently placed in liquidation, and our client forced to defend proceedings by the liquidator asserting that the funds should be repaid as an unfair preference.
Worse still, if a client’s guarantee documents have not been effectively drafted, there is no way of seeking recourse from the guarantors for funds repaid to a liquidator.
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When a payment to a creditor is clawed back by a liquidator or trustee in bankruptcy of the principal debtor, there is no avenue to pursue the guarantor for repayment of the debt under the guarantee. This is because on payment of that portion of the debt by the principal debtor, the guarantee has been extinguished.
To avoid being left in the unsecured creditor queue if a preference payment is clawed back by a liquidator or trustee in bankruptcy, a specific clause should be included in the guarantee which holds the guarantor liable in the event that a preference payment has been recovered by a liquidator or trustee in bankruptcy.
CONCLUSION
While a personal guarantee should simplify any recovery process, there are huge hurdles which can be thrown in a creditors path if they are not effectively drafted and executed. The examples discussed above are only the tip of the iceberg but are all too common and can be avoided with a little extra attention to detail.
Just because it looks right does not mean it is. Have your guarantees reviewed by a specialist for flaws to ensure that your existing guarantees do not leak, your internal systems and standard guarantee are strict and watertight and that any complex guarantees are individually drafted by a specialist.
When the time comes to call on your personal guarantees, you need them to work. It is not the time to discover that you were complacent and overlooked something along the way because one mistake can turn you into one of the examples above.
The devil is in the detail. If a job is big enough to warrant a personal guarantee then take the time to get it right, or the simple reality is that it may be useless.
