Technically, a guarantee is a written agreement between you and a third party to answer for the payment or performance of another person’s debt or obligations in the event of a default by the person who is primarily responsible.
That’s a bit of a mouthful so it is much easier to understand a guarantee from looking at the 4 most common examples that I see.
1) Guarantee to the bank for your child’s first loan
There has been a lot of discussion about the pros and cons of this for all involved in the media recently and ultimately the decision on whether to provide a guarantee in these circumstances is a decision for you, your child and your financial advisers.
Theoretically, in return for the bank agreeing to lend money to your child, you as a guarantor promise to pay the bank if your child does not pay. The giving of a guarantee in this circumstance involves considerable risk including the risk of losing any assets used as security for the guarantee including your home. The bank should insist that you obtain independent legal advice but regardless I cannot stress enough that given the risks you should always obtain independent legal and financial advice before signing a guarantee & indemnity.
My colleague Riley Driscoll has written more about this in her article The hidden dangers of guaranteeing a loan which follows the story of parents who provided a guarantee for a loan for their son’s new business.
2) Guarantee to the bank for your company
As you are likely aware, your company is a separate legal entity to you and will often have very few assets in its own name. It is for this reason that banks will often insist on the directors of a company providing a guarantee for the company when lending to it. Once again, the giving of a guarantee in this circumstance involves considerable risk including the risk of losing any assets used as security for the guarantee including your home. However in addition as you are the directors of the company it is important to be extremely vigilant if the company experiences financial difficulty and it is imperative to seek financial and legal advice regarding the company, the guarantee and your duties as directors.
3) Guarantee for your company on a Commercial Lease
As above, the landlord for a property will also often insist on the directors of a company guaranteeing the obligations of the company under the lease – most notably to pay rent. Although there is very rarely security provided for the guarantee in this scenario, the giving of a guarantee in this circumstances still involves considerable risk to your personal assets as if the company runs in to financial trouble you will become responsible for the payment of the rent which if the company is struggling may not be possible for you either. It is for this reason that independent financial advice on all guarantees is so important in addition to independent legal advice because you need to explore not just the company or borrowers financial position to make the payments in the first place but also your financial position to be able to take over those obligations if the borrower were to default.
4) Guarantee for company purchasing a property
When a company purchases property the vendor will often require the directors to provide a guarantee for the obligations of the company under the contract – most notably to settle and purchase the property for the agreed price. Even where a separate guarantee is not provided General Condition 19 of the standard contract makes the person who signs on behalf of the company personally liable in the event of default by the company. This is an important consideration, particularly where there are more than two directors of the company, because if the company is unable to complete the purchase for any reason the vendor can seek to force the directors who signed the contract to proceed with the purchase in their own names.
In all these examples even a seemingly straight forward arrangement can involve considerable risk if you guarantee the obligations of someone else; even if it is the company you are director of. You should always obtain advice about your specific circumstance when considering providing a guarantee.