Personal guarantees (PGs) are regularly sought to secure trade terms for company debt. Understanding the implications of PGs in the event of a company's failure is critical for both business owners and stakeholders.
1. Personal Guarantees Defined:
Personal guarantees represent a commitment by an individual, often a company director or shareholder, to take responsibility for a company's debts or obligations in case of default. These guarantees provide lenders with an added layer of security when extending credit to businesses.
2. Impact of a Failed Company and Personal Guarantees:
When a company fails, and it's unable to meet its financial obligations, the presence of personal guarantees ties the guarantor (often the director) to the debt. In such instances, the guarantor becomes personally liable for the outstanding debt (the balance the company does not pay), which could have significant financial and legal consequences.
3. Bankruptcy in New Zealand and Personal Guarantees:
In New Zealand, personal bankruptcy entails a legal process where an individual unable to pay debts is declared insolvent. Personal guarantees can exacerbate the situation for guarantors. In such cases, creditors can pursue the guarantor's personal assets (following a Court judgment) to recover the outstanding debt and failing payment, can opt to issue a bankruptcy notice and following that bankruptcy proceedings.
4. Legal Ramifications:
The consequences of personal guarantees in bankruptcy can include:
• Credit Rating Impact: Bankruptcy resulting from personal guarantees can significantly impact the guarantor's credit score, affecting their ability to secure credit in the future.
• Legal Proceedings: Guarantors may face legal actions to enforce the personal guarantee, leading to additional costs and stress.
• Bankruptcy: Guarantors may face a bankruptcy notice and then a legal proceeding and potential adjudication as bankrupt if the debt is not settled or paid
5. Mitigating the Risks and Seeking Advice:
Given the weighty implications of personal guarantees in case of company failure, individuals considering signing such agreements should proceed cautiously. Seeking legal advice before committing to personal guarantees is crucial to understanding the extent of liability and potential risks involved.
6. Alternative Risk Mitigation Strategies:
Exploring alternative risk mitigation strategies, such as limited liability structures, insurance options, or negotiating for limited or conditional guarantees, can help minimize personal exposure in case of company insolvency.
In conclusion, personal guarantees in the context of company failures carry substantial ramifications for guarantors. Directors and individuals should carefully evaluate the potential risks before committing to personal guarantees, seeking legal advice to fully comprehend the extent of liability and exploring alternative risk management strategies to safeguard personal assets. Being well-informed and proactive can significantly mitigate the financial and legal impacts of personal guarantees in times of business distress.
If you are facing pursuit of many company debts that you have personally guaranteed, an option is to reach informal settlements but care needs to be taken to not give preference. An option is to consider a Part 5 Subpart 2 proposal under the Insolvency Act 2006. To discuss your options contact MVP team.