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Perils of Company Directors and Personal Guarantees

23 July 2020

All people who trade under the umbrella of a company structure will most probably have signed guarantees to various entities such as suppliers, bankers, and the like. These guarantees are a device by creditors to get round the ‘Corporate Veil” of limited liability companies. In short, the creditor has another avenue to pursue in the event that the company defaults on its obligations to the creditor.
Most Solicitors will recommend that clients do not sign these personal guarantees.

If only if it was as simple as that. The catch 22 position that the Company Director finds themselves in is that if they do not provide the personal guarantee then the creditor is unlikely to supply goods or services or more importantly banking accommodation.



Are you personally liable?

Quite often, personal guarantees are tucked away in applications for credit accounts. For example, the owner of a Christchurch building company applying to Bunnings to run a trade account for supplies of timber and hardware. In that application form there will probably be an agreement and acknowledgment that there is a personal guarantee of the Director attached to the account.
It is important to remember that these guarantees remain in place until discharged by the creditor. The creditor has gone to the trouble of getting the guarantee in writing and all discharges should be similarly in writing.



When personal guarantees go wrong

An example of things going wrong can be found in the case of B & F Papers Limited v NZPC Holdings Limited. The Director of NZPC Holdings Limited, Mr McCormack signed a personal guarantee in favour of B & F Papers to cover NZPC’s debts to B & F Papers Limited. Things went along for some 5 years without problems. After 5 years NZPC started to fall behind on its payments and despite a payment plan for delayed payment being agreed to, the Company was unable to meet it.

Mr McCormack resigned as a Director of NZPC in March 2013. In 2015 B & F lost patience with NZPC because of the default of the payment arrangement and commenced proceedings against Mr McCormack to recover the outstanding amount under the personal guarantee he signed. Mr McCormack protested, he stated that the creditor company B & F Papers has released him from his guarantee by way of a discussion held between him and a representative of B & F shortly after he resigned his Directorship in 2013.

The Court found that Mr McCormack had mistakenly understood that the words used in that conversation meant that he was released from ongoing liability. The Court also rejected his alternative defence that the payment plan arrangements had somehow materially varied the contract so as to make the guarantee ineffective.

The Court found Mr McCormack was liable under the Guarantee, and noted that care needs to be taken in providing a personal guarantee when involved in business. It can be difficult to escape personal liability under such a guarantee even when no longer involved in the business.


Making sure you're protected

The take away from that case and others in similar circumstances is that in the event that you wish to be released from a personal guarantee whether that be from your bank (including a former bank) or a trade creditor it is important to obtain formal written confirmation that the guarantee had been discharged in order to prevent it coming back to bite even though you may no longer have any interest whatsoever in a business.

As noted above, the conundrum that a Company Director finds himself or herself in particularly when the business is in start-up mode is that credit is needed until sufficient cash flow has been generated in order to ‘pay as you go’. The creditor or the bank hold the upper hand in that credit facilities will not be advanced unless there is a guarantee provided.

You should always seek independent advice and that advice should be separate from the advice given to the Director wearing his or her company directorship hat in advancing the needs of the company. Bear in mind the ongoing effect on the Director’s personal assets and perhaps family assets in the event of things going wrong. The team at Godfreys Law can assist in attempting to limit the exposure to Directors when they exit a company, and there should be a full discharge or transfer of the guarantee away from the Director when the person is no longer in control of the company.

If you're being asked to sign contracts or provide guarantees to open up accounts, let us have a look at the paperwork first. We can help you to fully understand what you're signing up for, and may be able to suggest changes or help you negotiate the contract.

For more information, contact the team at Godfreys Law on 03 366 7469.

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