Enforcement of personal guarantees

COVID-19’s impact

The impact of COVID-19 will see some companies facing liquidation or entering into creditor compromises. Many companies are unable to pay their debts on time or are paying reduced amounts. The new business debt hibernation might also begin to be used more widely which could slow or reduce payments further and some creditors won’t survive financially if they can’t recover more of their accounts receivable. Creditors tend to be pushing hard for payment now and generally New Zealanders are giving each other as much leeway as possible to get through this tough time together.

If a creditor pushes hard enough they may get paid but then lose that payment later as a result of the debtor company going into liquidation. Payments prior to liquidation are at risk of being clawed back by the liquidator as insolvent transactions. That risk, and the Government’s recent law changes to the Companies Act 1993, are not the subject of this article. Instead, we’re explaining an alternative the creditor has – the personal guarantee. Many creditors include personal guarantees in their credit applications. They are sometimes vital to recovery.

Personal guarantee

A personal guarantee is relatively simple. An individual guarantees the payment of the debt of a company. Typically that person would be a shareholder, director, investor or someone that has a real interest in the company. Personal guarantees can also be provided by multiple guarantors in relation to the same debt. Companies or trustees can also provide guarantees.

Exact terms will vary, however, they generally operate as a fall back for the creditor. Should the company face liquidation or fail to pay then the creditor can enforce the personal guarantee against the guarantor rather than (or in addition to) the original debtor. The ability to enforce the debt against the guarantor can save the costs of pursuing a company that may just go into liquidation with little or no assets. The threat to an individual guarantor of bankruptcy, for example, will often result in money being found.

Minimum requirements

Section 27 of the Property Law Act 2007 sets out the minimum requirements for any personal guarantees entered into after 1 January 2008. Contracts of guarantee must be in writing and must be signed by the guarantor. The exact obligations in pre-printed forms or credit applications are usually carefully worded and rather specific.

Enforcement of personal guarantees

Before starting any formal enforcement processes the creditor should demand payment of the debt. In these difficult times, creditors should ask the debtor why a debt has not been paid and their intentions for paying the debt. This can be in the form of a phone call or an email to the debtor. This also reduces the risk of damaging the trading relationship by commencing legal proceedings too early. Sometimes there are genuine reasons for non-payment, or a complaint that needs to be dealt with.

The first formal step to take is the letter of demand to both the debtor and guarantor. This should set out the exact sum owing and the required time for payment. The time should be a reasonable amount of time in the circumstances. It should state that the creditor will commence legal proceedings to recover the outstanding debt if that is their intention. It should include a copy of the personal guarantee and require payment from the guarantor. If the terms of the guarantee require default from the debtor first then that default should be set out too. Often this is the point when creditors get their lawyer to write the letter of demand. That in itself is a pretty good signal that the creditor is serious about enforcement.

Enforcement through the Courts

Enforcement against the guarantor will depend on whether it is a company. If it is then the Statutory Demand process could be used. This requires legal advice as a Statutory Demand is the first step towards the liquidation of the guarantor company and should be handled carefully.

If the guarantor is an individual or trustee then proceedings should be filed in the District Court for under $350,000 or in the High Court for over $350,000.  If the guarantor or debtor disputes their liability and it’s less than $30,000 then a claim can be filed in the Disputes Tribunal.

Once judgment is obtained, the judgment creditor will have a range of enforcement remedies available which might include examining the judgment debtor’s finances, issuing a warrant to a bailiff to seize and sell property, sale orders of real property and bankruptcy proceedings

Being the debtor or guarantor

If you are the debtor or guarantor, the best thing you can do is get advice and act early.  Speak to your accountant and lawyer and have disputes dealt with early and before you begin incurring significant legal costs or put your assets at unnecessary risk. You might be able to get a payment arrangement negotiated. The best time to act is before the letter of demand but even if you receive one, the situation may still be recoverable. In an ideal world, creditors and debtors should work together to resolve debts and fortunately many are doing so as a result of COVID-19.