How do personal guarantees work?

Banks, landlords, suppliers and financiers often ask directors to guarantee company debts. A guarantee is a promise to pay if the borrower does not. Many include an indemnity, a separate promise to cover the creditor’s loss.

Where several people sign, liability is usually joint and several. The creditor can pursue any one guarantor for the full amount.

A creditor usually calls on a guarantee by written demand after default. The company’s liquidation does not release the guarantor.

During voluntary administration, a creditor generally needs the court’s leave to enforce a guarantee against a director or their spouse or relative. The protection is temporary (Corporations Act 2001 (Cth) s 440J). A similar protection applies in small business restructuring. A deed of company arrangement generally does not stop enforcement.

Can you challenge a personal guarantee?

Each guarantee turns on its wording and the facts. Common issues include:

  • Scope. Which debts, limits and time periods does the guarantee cover?
  • Variations. A material change to the loan or lease without your consent may release you, unless the guarantee provides otherwise.
  • Banking Code of Practice. For subscribing banks, the Code limits when a guarantee can be enforced. Some protections do not apply to director guarantors.
  • Unconscionable conduct. A guarantee obtained by exploiting a guarantor’s special disadvantage may be set aside (the Amadio principle). A spouse who signed without understanding or benefit may also be protected (the Garcia principle).
  • The amount. Interest, fees and costs may be open to challenge.

These defences depend on the evidence.

What if you receive a bankruptcy notice?

A creditor with a final judgment or order can ask the Official Receiver (AFSA) to issue a bankruptcy notice. The debt must be at least $10,000, and the judgment no more than six years old. You have 21 days from service to pay or reach an arrangement the creditor accepts. Failing to comply is an act of bankruptcy (Bankruptcy Act 1966 (Cth) s 40(1)(g)).

Setting aside a bankruptcy notice

You must apply to the court before the time for compliance expires. Grounds can include:

  • a counter-claim, set-off or cross demand at least equal to the debt (s 41(7));
  • a substantial or misleading defect in the notice;
  • the debt not being owed, or the notice being an abuse of process.

Only a counter-claim application extends time automatically. Otherwise, ask the court to extend time before it expires (s 41(6A)).

Creditor’s petitions

The creditor can then petition the Federal Circuit and Family Court of Australia or the Federal Court. It must show a debt of at least $10,000 and an act of bankruptcy within six months before the petition (s 44). The court may then make a sequestration order, making the debtor bankrupt (s 43). A debtor can oppose, for example by proving solvency.

What are the alternatives to bankruptcy?

  • Settlement. Creditors may accept instalments, security or a reduced sum. Where the Banking Code applies, paying the lower of the borrower’s debt and your guarantee limit ends your liability.
  • Debt agreement (Part IX, Bankruptcy Act). Strict debt, asset and income limits apply, so it may not suit larger guarantee debts.
  • Personal insolvency agreement (Part X). A flexible proposal managed by a controlling trustee. It binds creditors if a majority in number and 75% in value of those voting accept it.

What does bankruptcy mean for a director?

  • A trustee takes control of most of your assets and may sell them, including your home.
  • You must pay half your income above a set threshold to the trustee.
  • You are automatically disqualified from managing corporations (Corporations Act s 206B(3)).
  • You need your trustee’s written consent to travel overseas (Bankruptcy Act s 272).
  • Bankruptcy usually lasts three years and one day. A trustee’s objection can extend it to five or eight years.
  • Your name stays on the National Personal Insolvency Index permanently.

Transferring assets to family

A trustee in bankruptcy can recover:

  • property transferred for nothing or less than market value within five years before bankruptcy (s 120). Transfers more than two years earlier (four for related entities) are protected if the recipient proves you were then solvent;
  • property transferred mainly to defeat creditors, whenever the transfer occurred (s 121).

Lawful asset planning happens before liabilities arise, not after a demand.

What should you do when a guarantee is called?

  1. Do not ignore the demand. Note every deadline.
  2. Gather the guarantee, loan or lease, variations and correspondence.
  3. Check the amount claimed against the guarantee’s limits.
  4. Do not move assets or sign new security without advice.
  5. Get advice early on defences and settlement.

How Taylor David can help

We act for directors, guarantors, creditors, financiers and insolvency practitioners. We:

  • review guarantees, demands and defences;
  • negotiate settlements, instalment arrangements and releases;
  • apply to set aside bankruptcy notices and oppose creditor’s petitions;
  • act for creditors seeking recovery, and for trustees recovering property.

This work draws on our insolvency, reconstruction and turnaround and litigation practices.