Banks often require a loan be guaranteed by someone other than the party receiving it. While signing a guarantee may seem like simply another box to check, it is important to fully understand the terms of a guarantee before signing one, as it can have serious consequences.
A personal guarantee is an agreement where one party (called the “guarantor”) agrees to be responsible for the debt of another person or a corporation if they default on a loan. In the event the party receiving the loan does not repay it, the lender can require the guarantor to pay the outstanding amount of the debt, even if the guarantor received none of the benefit of the loan. This provides the lender an added layer of protection against default.
There are a number of situations in which personal guarantees are required. Business and corporate loans often must be guaranteed by the owners or shareholders. Lenders may require a guarantee from a related person for a student loan or an unsecured line of credit. They do not necessarily have to be connected to a loan, as corporate lease agreements also often require guarantees.
In Alberta, the Guarantees Acknowledgment Act sets out the rules for signing a guarantee. The Act states that a guarantee certificate must be signed in front of a lawyer, who must confirm that the guarantor understands what they are agreeing to. As a result of COVID-19, this can now be done over video conferencing platforms, such as Zoom.
By signing a personal guarantee, a guarantor can place themselves at risk of liability for significant sums of money. If the party receiving the loan does not provide repayment as required, or otherwise breaches the agreement, the lender will be able to require the guarantor to pay the outstanding amounts. If the guarantor is unable to make the required payments, legal action may be taken against the guarantor to recover the debt. Subject to any fact-specific defenses, courts are likely to hold a guarantor liable for the amount of the guarantee. If a judgment is issued against a guarantor, their personal assets are at risk of seizure.
A personal guarantee also puts the guarantor’s credit on the line. Unless the amount is paid off in the time required, the guarantor’s credit can be severely damaged.
There is no way to fully mitigate the risk associated with a guarantee, as a guarantor will always be financially responsible for the amount being guaranteed. However, speaking with a lawyer prior to signing the guarantee will help the guarantor understand the extent of the risk involved. Some guarantees are limited to a certain portion of the loan or amount due, while others are unlimited. An unlimited guarantee is inherently riskier, as the guarantor may become liable for the full amount.
The borrower may be able to ask the lender to change the personal guarantee to make it less risky for the guarantor. However, lenders often have a standard form guarantee agreement and may not be willing to negotiate any changes.
It is best practice for a borrower to compare multiple offers before choosing one. While each lender may not be willing to negotiate terms, canvassing the available options will help to ensure the borrower and guarantor get the best deal.
Whether signing a personal guarantee is the right choice will depend on your situation. There may be significant benefits to signing a personal guarantee. For example, a borrower may be able to qualify for a better rate of interest with the guarantee. However, if there is a significant chance that the borrower will be unable to repay the loan, the potential consequences are severe.
To make this decision, you should ensure you fully understand the risks, specifically what you can be held liable for under agreement. Speak with one of our experienced lawyers before agreeing to a guarantee to ensure that you have all the information you need in order to make your decision.