In any commercial agreement or transaction, financial security is key. All parties to an agreement want to ensure that their interests are protected. However, that’s not always an easy thing to ensure. After all, there are plenty of variables to take into account, and not all of those variables are known to both parties. In response to that layer of uncertainty, guarantors emerged. Guarantors undertake to guarantee the repayment of a loan, security of a lease, or performance of a contractual undertaking. As a part of that, it is the responsibility of a guarantor to remedy any default under the commercial arrangement of which he or she is a part. Those arrangements are many and varied, though, so let’s take a look at some of their more common forms.
There are a few common situations in which guarantor relationships may arise
Guarantors aren’t called upon in any and every commercial setting. Generally, only certain agreements or transactions require a guarantor. Notably, as well, it is up to the lender or lessor to decide if a guarantor is necessary at all. Of course, there are a few factors those parties will take into account when making that decision. To become acquainted with what those factors include, it’s important to know the most common guarantor arrangements.
Financial transactions often require guarantors
Loans are the most common source of guarantor arrangements. Normally, when considering a loan application, lenders will assess such factors as credit history, deposit size, employment, and financial history. But those factors aren’t always conclusive, especially if a borrower is young and without extensive financial or employment history. If lenders assess an element of risk, they might require a third party to guarantee the loan. The third party will need to demonstrate their credentials under the same criteria as the borrower. If they meet a certain standard, the loan will be approved. The borrower will then have fulfil his or her obligations under the terms of the loan. If he or she fails to do so, the guarantor will be called upon to rectify any defaults personally.
Company directors can act as guarantor as well
Under the Corporations Act, companies exist as a distinct legal entity. Company directors, then, face no liability for the debt incurred by their companies – unless they breach directors’ duties. However, that does not preclude lenders or parties to a commercial contract from requesting a guarantor. If that occurs, a company director may provide a director’s guarantee. A director’s guarantee places a company’s director in the position of guarantor. That director then assumes the liability of a company’s debt or commitment, should the company fail to meet its obligations. These arrangements are most common when the company in question is small, or without substantial assets. Directors ought to be wary of making such a commitment though; any debt or obligation unmet by the company will become that of the company’s director.
Some lease agreements also require a guarantor to assume certain responsibilities
A lease agreement is another agreement in which security is important. As a part of a standard lease, lessees are required to pay rent on a timely basis, and meet numerous obligations in respect of premises. As a result, such agreements often call for a guarantor. A guarantor to a lease agreement is a third party who agrees to pay any outstanding rent, or meet any other contractual obligation, on behalf of the tenant.
What effect might guarantor responsibilities have on guarantors?
So far, two primary guarantor responsibilities have emerged: the assumption of liability relative to both debt, and commitment. But those categories are quite broad, and they can manifest in different ways. Depending on the agreement entered by a guarantor, his or her obligations may be more or less stringent. That means that if an obligation is neglected by a borrower or lessee, guarantors may face varying burdens. Here’s what those burdens may look like.
In financial transactions, guarantors secure debt repayment
All loan agreements stipulate terms of repayment. These terms include timeframes, values, loan periods, and interest. If any of those terms are not met by the borrower over the course of the loan, the ensuing liability falls upon the guarantor. In basic terms, that means the guarantor will have to pick up where the borrower left off, and repay what remains of the loan, its interest and any attached fees. Consequently, if little of a loan has been repaid, a guarantor can be left with a substantial debt. Furthermore, none of that debt may be recovered in proprietary interests. What that means, is that the guarantor will not have the right to take ownership of any property over which the guaranteed debt extends. For example, if a guarantor is required to repay a mortgage over a house, he or she will not own that house when the debt is repaid.
Company directors can personally guarantee their company’s obligations
Like guarantors in loan agreements, directors can guarantee the security of debts and commitments in agreements between companies. For example, if a company wishes to borrow money, a director can undertake to secure a loan. However, such guarantees are particularly fraught. In general terms, directors’ guarantees are sought where a borrowing or contracting company has few assets. Such companies are normally relatively small, and may not have the financial depth to ensure the repayment of a large loan. Those companies therefore rely on cashflow to meet the terms of their loans. That places the company in a position of relative insecurity; any interruption to its cashflow could affect its repayments. Without a director’s guarantee, such an occurrence could render the company insolvent. And while that’s not ideal, it would likely have no effect on the personal liability of that company’s directors. However, with a director’s guarantee, missed repayments could be more serious: the director would become personally liable to repay what remains of the guaranteed loan.
Should you accept the responsibilities of becoming a guarantor? Here’s what to consider
Guarantors face significant responsibilities. Needless to say, it is not a decision to be taken lightly. Often, the decision to guarantee the loan of a friend, family member, or business, comes down to trust. However, it’s not always a matter of trust. In fact, someone who is entirely trustworthy may still fail to meet certain financial obligations. Often, that is due to reasons beyond anyone’s control. So before agreeing to guarantee a loan, it is important to think objectively. One way of doing so is seeking professional advice. That means going beyond the lender and the borrower, and looking for impartial legal or financial advice. Every case should be considered on its merit, but it’s important to know the precise scope and nature of a liability before you accept it.
By Finian McGrath
The information provided by Kafrouni Lawyers is intended to provide general information and is not legal advice or a substitute for it. Business people should always consult their own legal advisors to discuss their particular circumstances. Kafrouni Lawyers makes no warranties or representations regarding the information and exclude any liability which may arise as a result of the use of this information. This information is the copyright of Kafrouni Lawyers.
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