These days it is very hard to get any form of credit without a personal guarantee. Company directors, and sometimes even their spouses, are routinely called upon to sign guarantees for credit provided to the company. This could be to a trade supplier, equipment financier or bank. Often parents are asked to sign guarantees in favour of their children for home loans and other forms of bank finance. Once a facility is set, and a guarantee is in place, it can be very hard to get the other side to release a guarantee or alter the agreement. This is particularly the case with equipment finance agreements.
I have personally seen cases where the relationship between the guarantor and the borrower has changed. This can be due to a dispute between directors, a change in ownership or directorship of a company, a divorce or family dispute. Whatever the reason, guarantors can find themselves in a position where they are committed under a personal guarantee that they no longer wish to provide.
Often guarantees are provided for fluctuating facilities, such as bank overdrafts, lines of credit and supplier accounts. The amount potentially owed under the personal guarantee will go up and down, in line with the trading patterns and cashflow of the underlying business.
So, consider the case where a guarantee has been provided in relation to a bank overdraft. The guarantor no longer wishes to be involved. The overdraft limit is for $250,000. At the start of the month the account is in debit by $20,000 but by the end of the month the balance is debit by $200,000.
In this case the guarantor has the right to limit – or determine – their guarantee. Generally, this needs to be done formally, in writing, to the creditor (in this case a bank). Determining a guarantee is telling the bank that the guarantor will be liable for the amount owed on that day, but not for any future credit that may be provided beyond the date of determination. This means that the guarantor would not be personally liable for any future amount that may be owed, other than fees and interest on the amount of the debt at the date of determination.
As a rule, if the supplier, financier or bank wish to continue to provide credit to the borrower they will do so under a fresh agreement or contract. In any event, if the creditor allows the continued use of the facility after determination of the guarantee, the guaranteed debt could be recycled over time.
Determining a guarantee can be an effective way for a guarantor to limit their personal liability when there has been a change in relationship between them and the borrower. This is effective with fluctuating facilities, such as overdrafts, seasonal lines of credit and trade supplier accounts.
I was involved in one case where a father had guaranteed his son’s business loans and overdraft, and offered his family home as security. The son sold an investment property and paid down the overdraft substantially. The son had plans to reinvest the funds into his business to fuel further growth and expansion plans. The father had thought his guarantee would only be required until his son sold the property, and after the debt had been reduced his guarantee and mortgage would be released. This lead to dispute between the father and the son.
The father then decided to advise the bank he was determining his guarantee. At this time there was virtually nothing owing on the overdraft, and the son’s other business loans were well secured against other property. The bank froze the overdraft account and required the son to open a new account for ongoing trading and transactions. This account was not guaranteed by the father. In this way, the father was able to effectively manage his personal exposure under the guarantee.
On another occasion I was assisting a company director, and minor shareholder in a company. There was a dispute between my client and two other company directors. My client had personally guaranteed a range of bank and other finance facilities, including an overdraft and a floor plan. The company was not paying him any wages or dividends, and was refusing to repay a loan that it owed to him. The other two directors voted together to frustrate any attempts my client made to resolve the situation.
Our client made an offer to the other directors and shareholders to exit the business. This offer was very commercial, and reflected his desire to just move on. The other directors rejected his offer. The business had large monthly cash swings, with debts at their lowest level at the start to each month. Our client determined his guarantees to all lenders, including the overdraft and floor plan. This saw lenders freeze the company’s working account and floor plan, with the business required to make other arrangements. As it transpired, a settlement with our client was achieved two days later on substantially the same terms as originally proposed.
While not common, and effective in only some situations, determining a guarantee can help a guarantor limit their exposure, and potentially resolve other issues and disputes.