Without doubt, one of the most contentious and litigated issues in credit management these days is the practice of obtaining and providing personal guarantees.
We have just seen a large construction company personal guarantee case go through the courts with the guarantor found liable for more than NZ$1million.
Although the guarantor states that they will appeal this ruling, it highlights both the importance and danger of personal guarantees in the credit management arena.
For new companies (under two years old) applying for a credit account with a supplier and a personal guarantee being requested is typical and understandable.
If there is no long term data available to support the assertion that the account holder has the ability and intention to settle invoices as they fall due, if they are a subsidiary of a larger company with an established trading history then a corporate guarantee would be advisable also.
Getting a director of a large established company to agree to personally guarantee a trade account would be almost unknown outside of a major critical supplier situation.
One reason that a corporate guarantee is often advisable in supplying subsidiaries is the case of smaller subsidiaries that are either acquired or started by larger businesses when the consider the risk of having that business activity under the existing trading entity.
Too risky in an untested market
These can be seen as by the decision makers or stakeholders as being too risky due to risk of litigation or business failure in an untested market.
They are also at risk if the smaller business was acquired for a “Strip and Liq” where the business is purchased as a going concern, but the intention is to acquire infrastructure and client base and then liquidate the entity.
As always doing the correct due diligence before accepting an application for credit based on accurate historical credit data and having a perfected security interest will mitigate the risk for the supplier somewhat.
If possible, a Personal Guarantee or Corporate Guarantee will give you two shots at goal if the trading entity is not economical to pursue in a liquidation or insolvency event.
Often my clients ask me for some replies when their customers say to them “why do I need a personal guarantee, don’t you trust me?”.
The answer to this is quite simple: “Why don’t you want to sign it, do you not trust us?”
The simple fact of the matter is that when a customer asks to have an account on credit, they are in essence having the supplier and its stakeholders guarantee the account.
Most businesses of size will have access to institutional lending and most of this has a personal guarantee. So if the client doesn’t pay the supplier, someone still needs to pay the bank and they don’t often let you off just because someone didn’t pay you.
A quick story from the other side: a few years ago we were asked by a mother to investigate her daughter as she had been asked to put her mortgage free house up as security so her daughter could get a debt consolidation loan to pay her $50,000 worth of debts.
After one month of investigations we discovered that the daughter had four credit active identities, over $300,000 of uncollected debt and had allegedly been defrauding the government for years.
Had the mother not sought information and just gone with what she knew to be true, she would have lost her home.
The moral of this story is to acquire the only guarantee you have control over. And seek legal advice on how to mitigate the risk of doing so if you do commit to giving someone a second chance using your assets.
You could either be their savior or the victim of a poor decision. Only time will tell.