Australia: The dangers of directors guarantees

The dangers of directors guarantees

If you are a director of a company, it is almost inevitable that at some stage you will be asked or required to agree to a director's (also called a personal) guarantee.

As a director of a company, you may only be personally liable for the company's debts and claims to the extent that you may be in breach of your duties as a director. Except in circumstances where you have entered into a guarantee on behalf of the company.

Third parties such as banks, landlords and suppliers will invariably require directors of companies to guarantee that the company will repay its debts or otherwise discharge its liabilities.

So if the company is unable to meet its commitment, for example in the case of insolvency, then the third party can pursue the directors of the company personally.

While it is very common, and standard commercial practice, for such third parties to require director's guarantees, directors should be very vigilant and prudent when negotiating and entering into guarantees.

It is critical that directors fully appreciate the extent of their exposure, how that exposure may be limited, and their rights against the third party seeking the guarantee and indeed as against co-guarantors.

Here are the top 5 issues to be particularly aware of:

  1. Continuing guarantees

Most guarantees are not limited in time. A guarantor's liability is said to be "continuing" which means that the guarantor is liable for any past, present and future obligations owed by the company. The debt may be paid by the company at a given date, but the guarantor will still be liable for any subsequent indebtedness by the company.

  1. Joint and several liability

Many companies have two or more directors. Guarantees are therefore invariably sought from all the directors of the company, who will be liable jointly and severally for the debt to the creditor of the company. This means that the creditor is able to recover against one or other or all of the guarantors, in its absolute discretion, even if it has not exhausted all attempts to seek recovery against the principal debtor. The creditor will likely focus its recovery attempts on the guarantor with the capacity to pay or personal assets, that is, real estate, which it can attack.

  1. A director's guarantee does not cease when you cease to become a director

A "directors" guarantee is really a "personal" guarantee in that resignation as a director does not mean that you are automatically released from your obligations, particularly when the creditor does not know about the resignation.

We have acted in a number of cases where directors have resigned from companies some years ago, thinking they were "off the hook", only to find that they are the subject of a guarantee claim years later.

Such claims can often be hard to defend. It is therefore critical, when you decide to resign as a director of a company, that you ensure you obtain a signed release of your obligations from the creditor and any co-guarantors.

  1. All monies versus limited guarantees

Guarantees are either limited to the extent of money advanced to or owed by the company, usually a fixed amount, or they are considered an "all money" guarantee, that is, the guarantor's potential liability is unlimited and covers all monies due by the debtor company to the creditor. This is often the case with loans granted to debtor companies supported by director's guarantees.

It is very important to get legal advice on this topic as such clauses may not be entirely clear in the security documentation, even if it is in plain English.

  1. Right of contribution and subrogation

It is important to note that if one guarantor ends up "holding the baby" in relation to any guarantee claims, that guarantor can make a claim against any co-guarantors for what is called "contribution", assuming such co-guarantor assets have any money or assets.

Therefore, if you as a guarantor are subject to a claim because you are the only one with assets in your personal name, then you have a right to demand that any co-guarantors pay you their equal share for the debt, for what this is worth. The moral of the story here is not to have any assets in your personal

This is a highly technical area of the law even for lawyers and the Courts, let alone individuals or company directors involved in the hurly burly of business and contracts to sign. So you should take nothing for granted, before, during or after you have entered into a guarantee.

Please be constantly aware of your ongoing obligations and if your situation or that of the company with which you are involved changes at all, seek advice and take the appropriate action.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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