Guarantees are used in a variety of situations to secure a loan, lease or the performance of a contractual obligation. However, if you are considering becoming a guarantor, it is important you understand your responsibilities under the agreement, as there are certain risks involved.
What is a guarantor?
An individual or company that ensures the repayment of debts under a loan, commercial agreement or tenancy agreement, should the original party fail to meet their obligations or default. The written agreement to become a guarantor (known as a ‘guarantee’) is binding.
Who can be a guarantor?
An individual over the age of 18 who has capacity to provide financial assurance over a debt amount can be a guarantor. Companies or other legal entities can also become guarantors.
Common agreements featuring guarantors
Guarantors are commonly used in finance or loan transactions to ensure debt repayment. For example, banks may ask parents to be a guarantor for their child’s home loan.
A director of a company may also be asked to guarantee the company’s obligations to provide extra security. Generally, a company is its own legal entity and a director will not be liable for debt of the company unless they breach their director’s duties*. In some circumstances a director may be asked to personally guarantee the company’s obligations. For example, to secure a company loan or if a new supplier asks for a director guarantee.
A landlord may ask for a bank guarantee to ensure the performance of tenant obligations, such as the timely payment of rental amounts.
Commercial guarantees between companies may be used to ensure adequate resources in order to meet company debts or other obligations. These guarantees are commonly used between parent-subsidiary companies.
What happens if the guarantor is called upon?
The guarantor is responsible to remedy any default under the contractual arrangement. This may be in the form of repaying outstanding debts, unpaid rent, interest, charges or associated costs. If the guarantor cannot repay the loan, or the sale of any secured assets does not cover the debt, the guarantor may be sued or have their personal assets liquidated in order to satisfy the outstanding amount. However, you can limit your liability under in the guarantor terms and conditions (e.g. guarantee provided is capped to a specific amount).
Benefits of being a guarantor
Guarantors are a way to ensure the performance of obligations under an agreement and can help secure a loan, tenancy or other contract. Having a guarantor agreement in place can also substantially reduce costs involved with financing arrangements.
Before acting as a guarantor what issues should be considered?
- You should seek independent legal advice before becoming a guarantor to ensure you understand the guarantor commitments and responsibilities. This is a requirement for loans sought from banking and finance institutions**.
- Ensure you understand what you are guaranteeing and your responsibilities. For example:
- Loans – the total amount you are guaranteeing, any additional fees and charges. You should at least cap the guarantee to the amount borrowed under a loan agreement (plus any interest and other costs) or other reasonable amount under the agreement.
- Leases – the tenant’s repayment strategy (business plan) and any additional guarantor responsibilities.
- Director’s guarantee – your liability to the company or supplier. Exercise a high degree of caution and ensure your personal assets are protected.
- Commercial agreements – ensure you conduct your due diligence on the company and cap the guarantee, where possible.
- Consider alternatives to providing a guarantee (increasing assets used as security, other finance options etc.)
- Always look to limit the terms and amount of your guarantee.
- Finally, if you decide to go guarantor, ensure you maintain enough capital to ensure the terms of the agreement in case of a default.
* Corporations Act 2001 (Cth) ss 180, 588G, 1318.
** Code of Banking Practice, Clause 28.4