What Business Owners Should Know Before They Sign a Personal Guarantee

Personal guarantees are common in commercial transactions. A lender may require one before approving financing, or a landlord may ask a business owner to guarantee a commercial lease. Suppliers and equipment financing companies may also require a guarantee before extending credit. However, a personal guarantee can make a business owner personally responsible for a business debt, even when the original agreement was between a creditor and the company.

Signing a personal guarantee can seem like a routine part of doing business. The legal consequences can become much more serious when the company falls behind on its obligations and the creditor turns to the owner for payment.

At Gionet Fairley Wood LLP, we act for businesses and business owners involved in commercial disputes, including disputes arising from guarantees. When a creditor makes a claim under a guarantee, we look beyond the amount being demanded to examine the agreement, the underlying debt, and the circumstances surrounding the claim.

What is a Personal Guarantee?

A personal guarantee is a contractual promise by an individual to be responsible for another party's debt or obligations if that party fails to meet them. In Ontario, a guarantee generally must be in writing and signed by the guarantor to be enforced in court. 

In a business context, the company may be the borrower or customer, while the owner signs a separate agreement promising to pay if the company defaults. This can create personal liability for an obligation that would otherwise belong to the corporation.

The terms of the guarantee are important. Some guarantees are limited to a particular loan or transaction, or capped at a fixed amount. Others are written broadly enough to cover additional amounts or future obligations. Many guarantees also include an "indemnity" or "principal debtor" clause, which can make the owner liable as if they were the borrower and may remove defences a guarantor would otherwise have. 

A business owner should also understand how long the guarantee remains in effect. Selling the business, stepping down as an owner, or paying down part of the underlying debt does not necessarily release someone from a guarantee.

What Are the Risks of a Personal Guarantee

The primary risk is that a creditor may pursue the business owner personally when the company does not pay.

That can change the nature of a commercial debt dispute. A company may have limited assets or be unable to meet its obligations, but the creditor may still have a claim against an individual who guaranteed those obligations.

The amount claimed may also be greater than the original amount borrowed or owing. Depending on the agreement, contractual interest, the creditor’s legal fees, and other enforcement costs may form part of the claim. If the guarantee is secured, for example by a mortgage on the owner’s home, the creditor may also look to that security. 

There can also be complications when the business changes hands. A business owner may believe that selling the company or transferring responsibility for its debts removes their personal exposure. Unless the creditor has released the guarantor or the guarantee otherwise provides for that result, the original obligation may continue.

These are some of the reasons a business owner's personal guarantee should be treated as a significant legal obligation rather than simply another business document.

Can a Creditor Sue a Business Owner Under a Personal Guarantee?

A creditor can bring a claim against a guarantor when it says the business has defaulted on an obligation covered by the guarantee. Many guarantees require the creditor to make a written demand on the guarantor first. Most also allow the creditor to pursue the guarantor without first suing the company or enforcing its other security. 

However, receiving a demand for payment does not necessarily mean the creditor is entitled to the full amount claimed.

A dispute may arise over what the guarantee actually covers, whether the company was in default, how much is owing, or whether the creditor has complied with the agreement. There may also be questions about amendments to the original agreement or payments that have already been made. In some circumstances, a significant change to the underlying agreement made without the guarantor’s consent can release the guarantor in whole or in part although many guarantees are drafted to permit such changes. 

This is where the role of a litigator becomes crucial.

When we act for a business owner facing a guarantee claim, we do not simply look at the creditor's demand in isolation. We examine the guarantee alongside the underlying contract and the history of the business relationship. Correspondence, account statements, payment records, amendments and other documents can all be relevant to determining what is actually owed.

The legal issue is not always as simple as whether the owner signed the guarantee.

Can a Personal Guarantee Be Challenged in Ontario

A signed guarantee can be the subject of a legal dispute. The starting point is the wording of the agreement. The court may need to determine what the parties agreed to and what obligations the guarantee actually covers.

Other issues can arise depending on the circumstances. For example, there may be a dispute about whether the underlying debt exists, whether the amount claimed has been calculated correctly, or whether the creditor is relying on provisions that do not apply to the circumstances. There may also be allegations involving misrepresentation or other contractual issues surrounding the transaction.

The underlying business relationship is an important consideration. A guarantee cannot always be separated from the agreement and transactions that gave rise to the debt. 

For a business owner, this means it is essential to obtain legal advice before admitting liability or agreeing to a payment demand. A written acknowledgment of the debt, or even a partial payment can affect your legal position, including the time the creditor has to sue. A lawyer can assess the documents and determine what issues may need to be raised in response.

What Happens When a Creditor Makes a Claim?

A creditor may begin by sending a demand for payment. If the dispute is not resolved, the creditor may start a court proceeding against the business owner. In Ontario, claims of $50,000 or less (excluding interest and costs) can be brought in the Small Claims Court. Larger claims proceed in the Superior Court of Justice. 

Once litigation begins, there are procedural requirements and deadlines that need to be addressed. The owner may need to respond to the claim, preserve relevant documents, and develop a position based on the terms of the guarantee and the underlying transaction. In the Superior Court of Justice, a defendant served in Ontario generally has 20 days to deliver a statement of defence. If no defence is filed in time, the creditor may be able to obtain judgment without a hearing. 

This is not the point to rely on a general understanding of what a guarantee means. The specific documents and facts will determine the legal issues.

A litigator can assess the claim, identify potential defences, deal with the creditor's evidence, and represent the business owner through the court process. In some cases, the dispute may also involve a counterclaim or issues between the creditor and the company that affect the claim against the guarantor.

The goal is to establish what the business owner is actually legally responsible for rather than simply accepting the creditor's position.

What If the Business Cannot Pay Its Debt?

Financial problems within a business can make a guarantee claim particularly serious. A creditor that cannot recover the full amount from the company will often look to the guarantor and, depending on the guarantee, may not need to pursue the company first.. This can put the business owner's personal finances into the dispute.

The company's inability to pay does not, by itself, determine the owner's liability. The creditor still has to establish its legal entitlement under the guarantee.

The distinction between the company's debt and the guarantor's obligation can be important in litigation. The underlying debt, the terms of the guarantee and the creditor's right to enforce it all need to be considered.

A business owner who receives a demand should obtain legal advice promptly, particularly if court documents have been served. Delaying a response can result in missed deadlines and limit the opportunity to properly respond to the claim.

What Should a Business Owner Do If They Are Facing a Guarantee Claim?

The first step is to gather the documents and have the claim reviewed before making admissions or agreeing to payment. This includes the guarantee itself, the original business agreement, amendments, invoices or account statements, payment records and relevant correspondence. The circumstances surrounding the transaction may also be important.

At Gionet Fairley Wood LLP, our role in these disputes is to examine the creditor's position and determine the legal issues that need to be addressed. That may involve interpreting the guarantee, investigating the underlying debt, challenging the amount claimed, or defending the business owner if litigation has been started.

A personal guarantee can create real exposure for a business owner, but a demand for payment is not the end of the legal analysis. The creditor's rights depend on the agreement and the facts surrounding the debt.

Understanding those rights and obligations early can put a business owner in a better position to respond when a commercial debt becomes a personal legal dispute. We work with business owners throughout Barrie, Simcoe County, Muskoka, Grey Bruce County, and Ontario. Call us at 705-468-1088 or visit our website to speak with our commercial litigation team.

The information provided in this blog is for general informational purposes only and should not be construed as legal advice. If you have legal questions, we strongly advise you to contact us.