It is not uncommon in day-to-day commerce for lenders to obtain personal guarantees from the directors of companies seeking funding. This is a conventional and commercially sensible method of securing repayment of a loan.
This article explores how a guarantor’s liability may be discharged, and what lenders and guarantors should consider at the time a personal guarantee is given.
1. The Principal Agreement Between the Company and the Lender
At common law, the starting point is that if the company (i.e. the principal debtor) is released from liability, or if the terms of the loan agreement are materially varied without the guarantor’s consent, the guarantor may also be discharged from liability.
This principle is grounded in the fact that a guarantor’s liability is secondary to that of the principal debtor. If the principal debtor is discharged from liability, the guarantor will ordinarily also be discharged, unless the guarantee provides otherwise.
Lenders should therefore be mindful that substantial variations to the terms of a loan agreement may inadvertently release the guarantor. Depending on the wording of the agreement, variations may arise not only through formal amendments but also through the conduct of the parties.
A well-drafted personal guarantee can significantly reduce this risk by expressly preserving the guarantor’s liability, even where the underlying agreement is varied.
2. Discharge of a Guarantor’s Liability by Operation of Law
In certain limited circumstances, a guarantor may be released if the principal debtor is discharged by operation of law.
However, insolvency of the principal debtor does not usually deprive the lender of the right to enforce a personal guarantee. This is particularly relevant where the principal debtor is an individual. In such cases, the guarantor’s liability may continue even though the principal debtor’s liability has been compromised or extinguished through insolvency proceedings.
Similarly, in the context of commercial leases, where a company tenant’s obligations are supported by a personal guarantee, the guarantor’s liability will generally survive the tenant’s insolvency. For example, if the tenant company is wound up and the lease is disclaimed, the guarantor’s obligations typically remain enforceable.
These scenarios demonstrate that a guarantor’s liability can, in certain circumstances, outlive that of the principal debtor.
3. The Need for Clear and Express Terms
For lenders, the importance of clear and carefully drafted guarantees cannot be overstated. Modern personal guarantees typically include express provisions confirming that the guarantor’s liability continues notwithstanding:
- the discharge of the principal debtor;
- insolvency proceedings; or
- variations to the underlying agreement.
They also usually set out the specific methods by which a guarantor may be released from liability, thereby limiting the scope for disputes at the enforcement stage.
For directors and other individuals asked to provide personal guarantees, it is essential to understand the full extent of the risk involved. Even where independent legal advice is not legally required, it is strongly advisable. A personal guarantee may expose personal assets — including savings, property, and other investments — if the company is unable to meet its obligations.
Final Thoughts
Personal guarantees are a powerful risk allocation tool in commercial lending. For lenders, their enforceability depends heavily on careful drafting and disciplined management of the underlying agreement. For guarantors, the decision to provide one should be made with a clear understanding that liability may persist in circumstances where the company’s own liability does not.
Both sides benefit from clarity at the outset.
If you would like to discuss personal guarantees in more detail, our team can help you understand the next steps. Please contact us to arrange a conversation with one of our specialists.
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