In the intricate world of commercial transactions, personal guarantees can play a pivotal role, often acting as the safety net that binds business deals together by making a company director or third-party personally liable for the debt (or some part of the debt) if the company, as primary obligor, defaults on its repayments and/or other contractual obligations. To creditors, they offer an additional layer of security, assuring them that even if a company or individual faces financial turbulence, they can still hope to recover their losses from a guarantor’s personal assets or at least ensure that someone else has a personal stake in the company keeping to the contract. For companies, they can open doors to otherwise unattainable higher levels of borrowing, additional credit terms or greater opportunities. Some creditors also insist on including an indemnity which, simply, means that they can call upon the indemnifier even if the original agreement is called into question or can be challenged.

We are seeing increasing numbers of disputes, often years (even decades!) since a deal completed and guarantees and/or indemnities were signed: creditors seeking enforcement and recovery from a guarantor’s personal assets and guarantors and/or indemnifiers contesting the basis of the debt, the guarantee’s documented terms, the indemnity wording and/or the amount the creditor is claiming.

Guidance on personal guarantees and indemnities

This article contains specific guidance as to personal guarantees and indemnities for both guarantors/indemnifiers and creditors, but our key recommendation for both is to seek legal advice before entering into a personal guarantee in order to check the drafting, enforceability clauses and scope of the guarantee. Any reputable lender will wish to ensure they can prove – if necessary – that prospective guarantors and indemnifiers genuinely understood what they were getting into, and seeking such legal advice at the onset will hopefully go some way to avoiding any disputes later down the line, but for guidance in this respect, please see our section on resolving disputes.

What is a personal guarantee?

Simply put, a personal guarantee is a secondary obligation: a legally binding commitment made by an individual (the guarantor) to be personally responsible for fulfilling the financial obligations of another, normally business-related, party (the primary obligor) when that party cannot, for whatever reason, meet its own obligations. These secondary obligations can encompass a wide range of financial liabilities, including loans, property or asset lease agreements, and trade credit facilities.

Personal guarantees become enforceable from the moment the guarantee is in writing and has been signed by the guarantor. For instance, we often see personal guarantees being called upon when a company enters insolvent liquidation or administration, even if the amount (if any) of the company’s liability at that stage is uncertain. The guarantee represents at least a contingent liability of the guarantor and needs to be taken into account when considering their own solvency.

What is an indemnity?

Like a personal guarantee, an indemnity is a legally binding contract and normally created by deed. However, an indemnity is a primary obligation (unlike a personal guarantee): an express agreement to compensate for an identified loss if a particular trigger event happens (depending on the terms of the contract), independent from the obligations of the original parties.
We often see combined guarantees and indemnities which mean that the guarantor/indemnifier can be called upon regardless of whether the primary obligor is able to make payment; for instance, when there is a dispute between the original parties as to the terms or performance of an agreement, meaning that the original party may not honour its repayment obligations, leaving the indemnifier to cover the losses instead.

Guarantors and indemnifiers: what should I consider before signing?

As a prospective guarantor or indemnifier presented with a personal guarantee and/or indemnity to sign, you should consider your obligations and potential risks carefully; it is a serious commitment which should not be taken lightly. Seeking legal advice early is key to understanding and potentially restricting your obligations and the associated risks.

Some important considerations for the prospective guarantor or indemnifier include:

• Understanding the terms of the agreement by reading the guarantee and/or indemnity carefully.

Guarantees and indemnities often refer to the obligations of the principal parties, so it is vital that you understand the terms of the underlying agreement. You should additionally clarify the scope and limitations of the guarantee and indemnity – for instance, whether your guarantee/indemnity is open-ended or limited to a specific amount.

You should also be aware of the conditions which may trigger the guarantee and/or indemnity, together with termination and/or release clauses which may be included in your guarantee/indemnity.

Some guarantees and indemnities may be secured against an asset, for instance a property – you should ensure you, and any one else with an interest in that asset, understand what happens if that asset is called upon to satisfy your obligations as guarantor or indemnifier.

• Any financial implications, for instance your personal ability to meet the full scope of your obligations should your guarantee and/or indemnity be called upon. You should also consider the impact the guarantee and/or indemnity may have on your creditworthiness and personal assets like your property, vehicle, savings and investments.

Even if there are multiple guarantors and multiple indemnifiers in respect of the same debt, remember that these are most likely to be joint and several liabilities, meaning that each guarantor or indemnifier may be called upon separately to meet the entire liability. You may wish to agree with your co-guarantors and co-indemnifiers (by way of a separate binding agreement) to reimburse each other if one is called upon for repayment and the others are not, but of course this will only mitigate your liabilities if your fellow guarantors/indemnifiers are in a financial position at that time which allows them to contribute.

• Negotiate terms, if possible, to limit your personal exposure by imposing a cap on your liability or fixing the term of the guarantee and/or indemnity. You may also wish to insert a clause which allows you to resign as guarantor/indemnifier and/or transfer the guarantee/indemnity liability to another person if certain conditions are met (for instance, if you resign as director of the principal party). However, in practice, many lenders will likely have standard guarantees and/or indemnities which they may not be willing to amend.

• Monitor the principal parties’ financial health and performance, to help you anticipate potential issues and to take action before any default or dispute occurs. This is particularly important for guarantors where they are the secondary obligor. Is there some way you can mitigate your exposure by ensuring you have a degree of control over the primary obligor’s actions and/or access to records which might otherwise be confidential?

Our key suggestion is to seek independent legal advice before you sign a personal guarantee, to ensure you understand your rights and obligations, legal implications, consequences, and potential legal action which may be taken against you. Ultimately, if you are uncomfortable with the terms of the guarantee and/or indemnity, you should explore alternatives, for instance offering a security deposit, or exploring other ways to secure the debt. If you are a director of a company, particularly one which cannot obtain favourable credit terms without your giving an unlimited personal guarantee, bear in mind that your duties to the company do not require you to put yourself and your family at serious financial risk. It may be that, with the benefit of professional advice from an experienced solicitor and/or insolvency practitioner accountant, for example, you conclude that it is still in the company’s best interest if it secures a more expensive credit facility without personal guarantees, or even that the company’s business is no longer viable.

Guarantors and indemnifiers: Defending personal guarantee and/or indemnity claims

While personal guarantees are generally robust in terms of enforcement, there are instances where a guarantor or indemnifier may have valid grounds to challenge their liability. Some of these potential defences include, but are not limited to:

• • • Lack of capacity: If the guarantor/indemnifier can prove they lacked the mental capacity when entering into the guarantee/indemnity, it may be considered unenforceable.
    • Misrepresentation or material non-disclosure: If the creditor concealed essential information or made misrepresentations upon which reliance was placed to induce the guarantor/indemnifier into signing the guarantee/indemnity and/or if the guarantor/indemnifier genuinely believed the document they signed was of a wholly different character, it may be challenged.
    • Duress or undue influence: if the guarantor/indemnifier was influenced by duress (actual or threatened violence or unlawful restraint toward the person, a property or of an economic nature, for instance to terminate a separate contract), the guarantee/indemnity may be voidable.
    • Unfair contract terms: Guarantees and indemnities must be clear and not contain unfair terms; The courts can set aside guarantees with onerous or ambiguous clauses.
    • Illegality: If the guaranteed or indemnified obligation is illegal, the guarantee/indemnity itself is unenforceable.

Ultimately, guarantors and indemnifiers should seek legal advice before they seek to defend a guarantee or indemnity claim. In our experience, even if a guarantor/indemnifier is able to assert a defence, these disputes are often brought to an end by way of a full and final settlement of the guarantor/indemnifier’s liability, to avoid the costly and time-consuming court process for all parties involved. We often see – sometimes too late – guarantors/indemnifiers who have unwittingly prejudiced their own defences by making admissions and/or who thought they had settled their liabilities informally, only to find the settlement they thought they had was not binding in the way they intended, and who naturally regret not taking legal advice sooner.

Creditors: Common drafting mistakes for personal guarantees and indemnity agreements

Drafting a guarantee and/or indemnity agreement can be a complex and critical task. Making mistakes in such agreements can lead to costly legal disputes and financial losses in the event of non-payment. We often see creditors using the same precedent guarantee/indemnity agreements to secure countless loans, finance facilities and other liabilities, meaning that drafting mistakes could apply to each of those.

Some common drafting mistakes include the following:

• Incomplete or inaccurate information: failing to include essential details such as the names and contact details of the principal parties and the guarantor/indemnifier can lead to ambiguity and disputes.

Creditors should also consider running credit checks and/or verifying the prospective guarantor/indemnifier’s financial information before issuing guarantee/indemnity agreements in order to assess their ability to meet their obligations, the results of which may inform the creditor as to whether they require further security against assets.

• Unclear and ambiguous terms and definitions: ambiguous terms and definitions used inconsistently throughout the agreement can lead to misunderstandings and disputes. Creditors should also avoid including provisions that are overly broad, unconscionable, or against public policy as Courts may refuse to enforce these.

• Ambiguity in guarantor or indemnifier’s obligations: agreements should be specific about the guarantor and/or indemnifier’s obligations, including the scope of the guarantee, the trigger events, and the extent of liability.

• Failure to specify the governing law and jurisdiction: not specifying the governing law and jurisdiction can lead to uncertainty in the event of a dispute and make legal proceedings more complicated.

• Lack of clarity in the default, remedies and termination clauses: creditors should ensure that the guarantee / indemnity agreement clearly outlines what constitutes a default and the remedies available to each party in case of default. The agreement should also detail how and when the guarantee / indemnity can be terminated, either upon the occurrence of certain events or by mutual agreement. Failing to specify these can lead to disputes and/or ongoing obligations.

To avoid these mistakes, it is prudent for creditors to seek legal advice when drafting guarantee or indemnity agreements and to review their precedent agreements regularly with their legal advisors to ensure that the agreements are legally enforceable, fair, and adequately protect the creditor’s interests. Creditors should be mindful of the fact that standard wording will not necessarily suit every transaction and that the particular character of the proposed guarantor or indemnifier may require a more tailored document.

Resolving disputes

In this often complex and contentious area, settling disputes before proceedings need to be issued is often the most sensible course of action – reaching an accommodation early can save both parties substantial time and significant costs. Instead of engaging in protracted and costly court battles, parties can negotiate terms that safeguard their interests and reach a compromise.
Settlement not only saves time and resources but also allows the parties involved to maintain relationships, fostering a more positive business environment going forward, especially if there are multiple guaranteed / indemnified debts. The need for a settlement should never be seen as a sign of weakness; instead, it’s a sign of practicality and commerciality. In certain cases, it may be prudent to encourage settlement in advance of a dispute even arising, by providing a user friendly contractual mechanism for resolving disputes which can be mandatory or optional according to business need and the particular circumstances of the parties.

Further information and specific advice

We at Paris Smith have a great deal of experience with guarantees and indemnities, advising on them, drafting them and enforcing them, particularly in the event of an actual or threatened insolvency of a primary obligor.

If you would like to discuss any aspect of the above, please do not hesitate to get in touch with Lucy Andrews or Mike Pavitt – subject to running a quick conflict check against the names of any other parties with whom you may be in dispute or looking to enter into guarantee/indemnity terms with, we would be delighted to assist you.