What is a personal guarantee?

A guarantee creates a three-way relationship. The creditor lends to, or supplies, the principal debtor, and the guarantor promises to step in if the debtor does not pay. To be enforceable it generally needs a clear signed document and some consideration, which is usually the advance of credit itself. Many creditor-drafted guarantees state that the guarantor's obligation is independent of the debtor's, so the creditor can call on the guarantor without procedural delays.

A continuing guarantee covers ongoing obligations such as an overdraft, while a single-event guarantee covers one transaction. If the principal contract is varied in a way that increases the guarantor's risk without their consent, the guarantee can be discharged or reduced. That is why creditors often include clauses allowing variations without consent, and why those clauses are heavily negotiated.

An unlimited guarantee makes you liable for all the debt, past and future, and carries the highest risk. A capped guarantee limits liability to a set dollar amount, which gives predictable exposure. A continuing guarantee covers a series of transactions such as ongoing supplier credit, and a conditional guarantee only bites on a trigger such as default plus demand.

Under a joint and several guarantee each guarantor is separately liable for the whole debt, so a single guarantor can be chased for everything even if others signed. A limited-to-assets guarantee confines liability to one asset, such as a property or a vehicle. Creditors prefer unlimited, continuing, joint and several guarantees; guarantors prefer caps, time limits and proportionate liability.

After a default the creditor issues a demand, may accelerate the whole outstanding sum and can add default interest and recovery costs. It can then seek a court judgment and enforce it through charging orders, garnishee orders or seizure of assets, or sell any asset that secures the guarantee. If the company goes into liquidation, the creditor pursues guarantors for the shortfall after company assets are realised; if the guarantor becomes insolvent, a trustee in bankruptcy takes control of their assets.

Defences that can reduce or defeat a guarantee include misrepresentation, undue influence or unconscionable conduct, lack of capacity, defective execution, variation of the principal contract without consent, and unfair contract terms protections in some small business and consumer settings.

The main levers are a fixed dollar cap, a sunset date or termination on repayment, a scope limited to a named facility rather than all future liabilities, and proportionate rather than joint and several liability where several people sign. Automatic release on refinance by an unrelated lender, or on sale of the business, is also common.

Other protections include notice and cure rights, a requirement that the creditor pursue the company's assets first, carve-outs for superannuation or the family home where possible, and independent legal advice of your own before you sign. The signed acknowledgment that you took that advice is standard lender practice, and it is there for the lender's benefit rather than yours. Red flags are open-ended liability with no cap, pressure to sign immediately, and guarantees that survive refinance or sale indefinitely.