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When seeking a loan for your business, many banks will also require you personally to guarantee the company’s obligations. This can have profound effects, especially if your company defaults. Therefore, understanding the legal and commercial implications of entering a guarantee agreement is helpful. This article will explain how the law behind guarantee agreements operates.
Guarantee Agreements
The bank cannot chase a company’s owners if it does not have enough assets to repay a loan. The exception is if it can get the company’s owners to agree to promise that if the company fails to meet its loan obligations, the owner will meet the obligation instead. This is called a guarantee agreement.
There are three parties in a guarantee agreement, including the:
- borrower, such as your company;
- lender, such as your company’s bank; and
- owner of the company.
While a loan is an agreement between your company and its bank, the guarantee agreement is a separate contract between you and the lender. If you enter into a guarantee agreement with your company’s bank, the law refers to you as the “guarantor”.
Implications of Being a Guarantor
Because the guarantee agreement creates a second contract between you and the lender, if the company breaches the loan terms, the lender has a right to come to demand payment from you. If you refuse, the lender can sue you in your capacity.
This is important because a business owner is usually not liable for the company’s debts. However, the guarantee agreement creates a separate legal mechanism the bank can use to recover its money.
Therefore, you should not enter into a guarantee agreement unless you are reasonably confident that either:
- your company can honour its obligations under a loan agreement; or
- you are prepared to meet the obligations yourself personally.
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Other Implications
Guarantee agreements can create several legal issues, depending on how they are drafted and the circumstances surrounding your business and the loan with its bank. Therefore, you should consult a solicitor before signing any guarantee agreement.
Some other implications you should be aware of include:
- potentially granting the bank security rights in your property;
- any future cancellations, particularly where you substantially modify the loan agreement;
- the legal effect of the guarantee agreement where the loan agreement becomes void;
- your ability to “set off” any money paid to the bank from the amount you owe; and
- your entitlement to the security interest the bank holds in your company’s property.
Practical Considerations
As a business owner, guarantee agreements do not generally work in a borrower’s favour. You may wonder why any business owner would agree to guarantee their company’s debt considering that you are otherwise not obligated to do so.
The answer is that nearly all commercial company loans for small businesses will require a guarantee agreement. The bank is unlikely to lend to your company if you do not consent. Therefore, before your company obtains a loan, you should ask yourself if you are prepared to guarantee your company’s debts.
Key Takeaways
As a condition of lending, many banks require small business owners to “guarantee” their company’s performance under the terms of the loan agreement. You will have created a separate contract with the bank by entering into a guarantee agreement. If your company defaults on the loan, the bank will be entitled to demand payment from you in your capacity. This effectively means that you no longer benefit from the principle of limited liability. Therefore, you should carefully consider if you are prepared and capable of honouring your company’s liabilities in the event it cannot.
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Frequently Asked Questions
A guarantee agreement is a separate contract between your company’s bank and you. The agreement gives the bank the right to chase you if your company defaults on its loan and demands that you repay the amount.
From a commercial perspective, if you want your company to receive a loan, you rarely have any choice but to sign the guarantee agreement. Otherwise, the bank will refuse to lend.
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