The purchase and sale of a business can involve a plethora of financial risks – one of which is often mitigated by requiring a personal guarantee. In the private M&A context, personal guarantees can have important implications for the buyer, who is signing the guarantee, and the seller, who requires the guarantee. These implications become further complicated when the transaction spans multiple jurisdictions and will require careful legal analysis.
Typically, the sale of a business will require financing. The person or entity financing the purchase may be the seller (in which case, the seller also becomes the lender) or a third party. In any event, the seller/lender may require the personal guarantee of one or more individuals associated with the purchaser. This guarantee is essentially a promise by the guarantor that the buyer will fulfill its obligations to the seller/lender. If the principal defaults, the lender will have a contractual right to seek repayment from the personal assets of the guarantor. By taking this approach, the lender can be satisfied that the borrower has sufficient personal interest at stake in the business, and as a result, will be proactive in making sure that payments are made to the lender until the loan is paid in full. While assuming this liability may be burdensome, it is often necessary in order to reach a deal.
Risks to consider
Acting as a guarantor for a commercial loan can create a significant burden for the gurantor and their families. While it is advisable to require indemnification from the company which the guarantor is signing on behalf of, in the event that the guarantor is required to make payment on a defaulted loan, the guarantor may still experience difficulties. For example, the factors which contributed to the default (i.e., poor business performance, financial trouble, etc.) will likely cause repayment to be delayed or in some scenarios, may render the company unable to reimburse the guarantor at all. There is also the added risk that the personal guarantor may pass away, in which case the lender’s interest will be placed in priority to the children and spouse of the deceased guarantor when distributing assets from the guarantor’s estate.
Reducing the risks
There are various ways to reduce these risks associated with providing a personal guarantee, some of which include:
- Key person life insurance: One way to reduce risk is to have the business purchase key person life insurance for those signing a personal guarantee on the company’s behalf. If an insured guarantor passes away, the insurance plan will, among its other benefits, ease the lender’s concerns about the company’s financial health and ensure that surviving co-guarantors and/or their families will not be left with the debt of the business. Key person life insurance also benefits the lender as it provides a source of funds to ensure debts are paid if the guarantor is unable to continue working.
- Forms of liability: Where there are multiple guarantors, it may be advisable to avoid joint and several liability as a guarantor. This term will allow the lender to seek repayment from one or all of the personal guarantors, as opposed to having any amounts owed shared equally amongst co-guarantors.
- Termination date: In some cases, it may be possible to negotiate a termination date with the lender, upon which the personal guarantee will expire. This provides the guarantor with certainty that the lender will only be able to demand repayment from the business itself after a certain point in time.
Finally, in a scenario where the transaction involves various jurisdictions, there are additional issues to consider when a personal guarantee is being provided. For example, if a personal guarantee is signed by an individual resident in Alberta, the Guarantees Acknowledgement Act (Alberta) (the Act) will come into play which could have a dire impact on the seller/lender. To be more specific, under the Act, an individual signing a personal guarantee must appear before an active member of the Law Society of Alberta and acknowledge giving the guarantee. Once the lawyer is satisfied that the individual signing the guarantee is aware of the contents of the guarantee and understands its significance, he or she must sign a certificate to that effect and attach the certificate to the guarantee. Only then will the guarantee be enforceable. By failing to comply with such formalities which are imposed by the Act, the guarantee could be rendered unenforceable. Case law has demonstrated that courts will not have jurisdiction to waive non-compliance or to apply the rules of equity, even where the result may seem absurd.
Needless to say, purchasing a company can involve significant risks when a personal guarantee is required. However, with proper planning and careful consideration, the risks associated with personal guarantees can be mitigated for the betterment of the seller and buyer alike.
The author would like to thank Joseph Palmieri, Articling Student, for his assistance in preparing this legal update.
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