Personal guarantees are a useful tool when an individual is wanting to purchase or start a business. A personal guarantee is an individual’s legal promise to repay credit or a loan issued to a business for which they serve as a director or executive. This provides an extra level of protection to the creditor issuing the loan, as in the event the newly-formed company goes into liquidation and cannot repay the loan, the creditor can look to the guarantor to satisfy the debt in full.
Given the important role personal guarantees play in facilitating large loans and protecting creditors, it is critical to ensure that personal guarantees are actually enforceable. Recently, in Brougham v Regan, the Supreme Court held that a loan document which named Mr Brougham as a “Guarantor” was not a valid personal guarantee.
The case provides a harsh reminder that creditors must ensure that personal guarantees are legally binding or else they run the risk of their loans being unprotected (i.e. not guaranteed by the guarantor).
Mr Brougham and Ms Dey were in a relationship and agreed to jointly purchase a business together. They set up a company for this purpose and Ms Dey arranged for the Winchester Trust to loan the company the $50,000 it needed to purchase the business. The loan, which was printed on a standard Auckland District Law Society form, identified the “Guarantors” of the loan as Mr Brougham and Ms Dey. The original intention of the parties was that Mr Brougham and Ms Dey would each personally guarantee $25,000 of the loan; however, this was not documented in the loan document itself. The second page of the loan agreement contained the following provision:
“If any person is named in this agreement as a guarantor, the guarantor must have signed a deed of guarantee and indemnity in the form required by us and the conditions precedent to the acceptance of that guarantee (if any) must have been completed to our satisfaction.”
Ms Dey signed the agreement as a director of the company – but not as a guarantor. Mr Brougham, on the other hand, signed as both a director and guarantor. No separate guarantee document was prepared or signed, this being because the trustees of the Trust did not believe it was necessary after Mr Brougham signed the loan as a “guarantor”.
Mr Brougham and Ms Dey’s relationship subsequently ended and the company was liquidated. The trustees thereafter attempted to enforce the guarantee against Mr Brougham, which Mr Brougham resisted.
Section 27 of the Property Law Act 2007 (the Act) requires that a contract of guarantee must be:
- In writing; and
- Signed by the guarantor.
In Brougham v Regan, the principal issue was whether the loan document constituted a “contract of guarantee” under the Act.
Supreme Court’s decision
The Supreme Court held that the loan agreement did not satisfy Section 27, as it did not include any provision under which Mr Brougham agreed to answer to the trustees for the debt, default or liability of the company. The Court explained that “a contract for guarantee” was defined as a “contract under which a person agrees to answer to another for the debt, default or liability of a third person.”
Whilst the loan agreement was in writing and referred to Mr Brougham as the “guarantor”, it otherwise lacked the necessary elements to constitute a guarantee under the Act.
The Court stated further that even if Section 27 were satisfied, the guarantee was likely unenforceable. This was on the basis that the loan document, on its face, provided for two guarantors and for it to be a valid guarantee all guarantors needed to sign the document. Here, only one of the two named guarantors signed the document and, therefore, it would have been invalid regardless.
As the trustees in Brougham v Regan learned, it is important to ensure that if a personal guarantee is intended to apply that the loan document qualifies as a personal guarantee or, if necessary, a separate guarantee and indemnity document is executed (which should have been done in the present case).
We recommend that parties always seek independent legal advice when giving, or receiving a personal guarantee. The consequences for the creditor of getting it wrong can be substantial. Equally, we often find that people do not understand the full extent and consequences of giving a personal guarantee.
If you have any questions or concerns about a loan or personal guarantee you have, or are considering giving, feel free to come chat with someone from our team.