30/03/2015

When taking out a loan, many lenders will require a guarantee be given – a promise that in the event a borrower cannot repay their debt, someone else will step in and take responsibility for the outstanding amount.  

But what happens when the outstanding debt is greater than the amount the guarantor thought they were agreeing to be liable for? As the recent case of Sharp v AME Products has shown, the answer depends on the terms of your guarantee.

Mr Sharp was the director of an electrical services company which had applied to a product supplier for a $20,000 credit facility. The terms of the application allowed for the supplier to review and vary the credit limit of an applicant at any time. Mr Sharp also signed a personal guarantee ensuring payment of any outstanding balance in the event that his company defaulted.

Only two months after receiving approval for the application, Mr Sharp's company had accumulated over $105,000 in debt through the credit facility and the supplier sought payment.  Taking the dispute to court, Mr Sharp argued that he was only liable for $20,000 as outlined in the application and not the larger amount of $105,000.  The Supplier argued that the $20,000 application was merely a request and not an agreed limit as the supplier had the express power of changing the limit at any time without Mr Sharp's consent.

The court quickly sided with the Supplier based on two factors.

Firstly, the agreement made no mention of a credit limit, merely an initial amount that the company had applied for. Indeed the company itself did not see the supposed limit as a barrier to making substantial credit applications in a very short period of time.  

Secondly, the guarantee stated in very broad terms that Mr Sharp would be liable for "all monies which may at any time be payable".  Again, no limit on the amount of credit to be guaranteed was mentioned.  Mr Sharp was ultimately ordered to pay the full amount sought by the supplier, as well as interest and costs.

Mr Sharp's predicament serves as a clear warning that the terms of a guarantee may be more far-reaching than they appear at face value.  It is therefore crucial that before you sign any guarantee, you are aware of all the potential consequences.

When it comes to SMSFs and their lenders, it can get even trickier.  Banks in particular will often require trustees/directors to sign guarantees when a limited recourse borrowing arrangement is involved. In this scenario, not only do you need to consider your potential liability but also the impact it might have on the SMSF.  The terms of the guarantee can easily breach superannuation law if not prepared in the right way.

Before signing any guarantee, we strongly recommend you consider obtaining a legal opinion to ensure that you don't end up getting hit with more than you can chew.

For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222.