Personal Guarantee - Risks on Default

Your Calgary lawyer to advise on personal guarantees and Guarantees Acknowledgment Act Certificate.

Personal Guarantee & GAAC  |  Bank Loan  |  Financial Obligation  |  Commercial Lease  |  Car Loan  |  Student Loan

Contact Neufeld Legal PC at 403-400-4092 or Chris@NeufeldLegal.com

A personal guarantee is a legal agreement where an individual (the guarantor) promises to be personally responsible for the debt or obligations of another person or a company (the primary debtor) if they default. By providing this legal assurance that they will assume responsibility for the indebtedness should the primary debtor default, this effectively satisfies the concerns of the lender, such that they might proceed with completing the underlying transaction with the primary debtor (i.e., bank loan, financial obligation, commercial lease, franchise, car loan, student loan).

Key Reasons why a Personal Guarantee is Required

• Mitigating Risk for Lenders - The primary reason for a personal guarantee is to reduce the lender's risk. Businesses, especially startups, may not have a long credit history or a lot of assets to use as collateral (just like young adult children, for whom parents are often sought as guarantors). In the event the business defaults on its debt, a personal guarantee allows the lender to go after the personal assets of the business owner or director to recover the outstanding funds. This could include their home, savings, or other investments.

• Providing Access to Financing - For many new or small businesses, a personal guarantee is the key to getting a loan. Without it, the business might be seen as too high-risk for a lender to approve. By personally guaranteeing the loan, the business owner shows their commitment and gives the lender the confidence they need to provide the funds.

• Incentivizing Repayment - When a business owner's personal finances are on the line, they are more likely to be diligent about making loan payments. This creates a strong incentive for the business owner to ensure the business is successful and meets its financial obligations.

• Overcoming Limited Business Credit History - If a business is new, it may not have an established credit history or a good business credit score. In this case, the lender can use the business owner's personal credit history and financial profile as a basis for underwriting the loan.

• Securing Unsecured Loans - A personal guarantee is often required for unsecured business loans, which are loans not backed by business assets. The guarantee provides the lender with an alternative form of security to fall back on if the business fails.

Risks of providing a Personal Guarantee

• Loss of Personal Assets - This is the most significant risk. If the business (or individual primary debtor) fails to repay the debt, the lender can go after your personal assets to recover the money owed. This can include: your home or other real estate, personal savings and investments, vehicles, and other valuable possessions. For many business owners, this risk can lead to financial ruin and even bankruptcy if their personal assets are not enough to cover the debt.

• Impact on Your Personal Credit - A personal guarantee ties your personal credit to your business's financial health. If the business defaults on the loan and you are unable to make the payments as the guarantor, this will negatively impact your personal credit score. A damaged credit score can make it difficult to secure future personal loans, mortgages, or credit cards.

• Unlimited Liability - In many cases, a personal guarantee is "unlimited," meaning you are responsible for the full amount of the debt, including the principal, interest, legal fees, and any other associated costs. This can be particularly dangerous if the business's financial troubles are severe, as the amount you are liable for can be much greater than the initial loan amount.

• Legal Action and Bankruptcy - If the business defaults and you are unable to pay, the lender has the right to initiate legal proceedings against you. This can result in a court judgment, which may lead to wage garnishment, seizure of assets, and in the worst-case scenario, personal bankruptcy. Filing for personal bankruptcy can have long-lasting consequences and may disqualify you from serving as a company director.

• Strain on Personal and Business Relationships - If you sign a personal guarantee with business partners, it can create a "joint and several" liability, meaning each partner is individually responsible for the entire debt. If one partner cannot pay their share, the lender can pursue the others for the full amount. This can lead to serious disputes and legal battles among partners. The financial and emotional stress of a potential business failure can also put a significant strain on personal relationships with family and spouses who may be affected by the loss of assets.

Important Note for Guarantors: For anyone considering becoming a guarantor, it's crucial to understand the significant financial responsibility and risks involved. They are legally obligated to fulfill the terms if the primary party defaults, and this can have serious consequences for their own finances and credit history. Consulting with legal and financial professionals before signing a personal guarantee is highly recommended [more for guarantors]. 

When you are in need of legal representation with respect to the provision of a personal guarantee for another party's indebtedness (i.e., bank loan, debt financing, commercial lease, student loan), including the proper completion of a Guarantees Acknowledgment Act Certificate, contact Calgary lawyer Christopher Neufeld by email at Chris@NeufeldLegal.com or by telephone at 403-400-4092.