The risks of providing a guarantee

Providing a guarantee for someone else’s financial commitments can expose you to serious legal and financial risks. Before agreeing, ensure you understand the potential consequences - especially if you won’t directly benefit or lack full visibility and control over the obligation.  

A guarantee is a legally binding commitment where one party (the guarantor) agrees to take responsibility for another party’s (the borrower or principal) financial or performance obligations if they fail to meet them. This means the guarantor may be required to repay the debt or fulfill the obligation, exposing them to financial risk without gaining any direct benefit from the original contract.

Full Liability for the Loan Debt

As a guarantor, you are responsible for repaying the loan if the borrower defaults. The lender can demand full repayment from you - including interest, fees, and penalties - without first trying to collect from the borrower.

Depending on the loan amount, you may need to use personal savings, sell assets, or take out loans to fulfill these obligations. If you have offered your home or other assets as security for the guarantee, the lender may enforce these claims. If you are unable or unwilling to pay, the lender can take legal action against you, which could harm your ability to obtain credit in the future or even lead to bankruptcy/liquidation or similar.

Difficulty in Withdrawing from a Guarantee

Once you've given a guarantee it may be very difficult to withdraw or be released from liability. The lender generally retains the right to hold you accountable until the borrower fully repays the loan and you request (and are granted) a release. This could tie you into the arrangement for years and may limit your borrowing capacity or access to prime lending rates - the guarantee will be considered a liability.

Strain on Personal Relationships

You should also consider the potential strain on your relationship with the borrower. If they default and your guarantee is enforced by the lender, it may create tension or damage your relationship.

What if the Party You've Guaranteed Then Guarantees Someone Else?

Be aware – if the entity you are guaranteeing gives its own guarantee in respect of a third party (which fails to make its own payments), the stack of cards starts to collapse as guarantees are considered and called up. Know the party you are guaranteeing.  

Summary

Considering the risks involved, it’s important to carefully assess your reasons and willingness to grant a guarantee. If it is possible under the terms, consider requesting security (or an indemnity) from the borrower for your guarantee.

You should understand the borrower’s financial stability, seek independent financial advice about your own ability to meet these obligations, and where possible, negotiate a limit on the amount you will guarantee.

Never give a guarantee lightly. Review the terms of the guarantee to understand when and how the lender might enforce it. Understand what might occur in the event of default. Proceeding with caution and a full understanding of the implications of a guarantee is essential.

If you’re considering providing a guarantee, it’s essential to get legal advice tailored to your situation. The team at McVeagh Fleming can help you assess the risks and negotiate terms to better protect your interests- contact me for a conversation.

Hamish Coupe

Email: hcoupe@mcveaghfleming.co.nz

DDI: 09 950 5986

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