You may feel that becoming a guarantor is an easy way to help a family member, friend or business associate secure finance for a business venture or commercial property. After all, you may be a parent wanting to help your child start a business, or a partner wanting to support your spouse’s business ambitions.
However, many people do not fully understand the legal and financial risks involved. That is why lenders, like banks and independent lending institutions, often require guarantors to obtain independent legal advice before signing loan documents.
What Is a Guarantee?
A guarantee is a legal promise to repay a debt if the borrower cannot meet their obligations. If the borrower defaults on the loan, the guarantor can become personally responsible for:
- the outstanding amount,
- interest,
- penalty interest,
- legal enforcement costs.
In some situations, the guarantee may also place the guarantor’s personal assets, including their home, at risk.
Why Is Independent Legal Advice Required?
Lenders require guarantors to obtain independent legal advice to ensure guarantors fully understand the seriousness of the obligations they agreeing to. Many people sign guarantees believing they are simply supporting a family member or helping a business secure finance, without appreciating that they may ultimately become responsible for repaying the debt themselves.
Our Commercial Lawyers frequently give independent legal advice to guarantors who may need the following confirmed:
1. The extent of their liability
A guarantor should fully understand the extent of their legal and financial liability before signing any guarantee or loan-related documentation. Depending on the terms of the guarantee, a guarantor may be responsible for part of the debt or the full amount owed under the loan agreement, including interest, fees, enforcement costs, and legal expenses.
For example, if a borrower defaults on a $250,000 business loan and cannot repay the debt, the lender usually seeks repayment from the guarantor. Depending on the terms of the guarantee, this may include interest, enforcement costs and legal expenses in addition to the outstanding loan balance.
2. The circumstances in which the lender can enforce the guarantee
A guarantee may become enforceable if the borrower breaches the terms of the loan agreement. This can include missed repayments, insolvency, failure to comply with financial obligations, or other events of default outlined within the loan documentation.
For example, if a borrower stops making repayments on the loan, the lender may have the legal right to pursue the guarantor for repayment of the outstanding debt.
3. Any unforeseen or potential consequences if the borrower defaults
Acting as a guarantor may carry significant financial and legal consequences if the borrower defaults under the loan agreement. A guarantor’s personal assets, borrowing capacity, credit position, and future financial opportunities may be affected.
For example, lenders may consider an existing guarantee as an ongoing financial commitment when assessing future loan applications. In more serious circumstances, legal recovery action may also be taken against the guarantor to recover unpaid amounts owing under the loan.
In some circumstances, a guarantor may face legal proceedings or bankruptcy if they are unable to satisfy the guaranteed debt.
Obtaining independent legal advice allows the guarantor to ask questions and receive clarity in relation to their personal circumstances before signing legally binding documents.
This process not only protects the guarantor, it also protects the financial lender. If a dispute later arises, a guarantor may claim they did not understand the documents, were pressured into signing or relied entirely on the borrower’s explanation of the arrangement.
By requiring guarantors to obtain independent legal advice, lenders reduce the risk of future disputes and strengthen the enforceability of the guarantee if enforcement action later becomes necessary.
How to obtain Independent Legal Advice
During the meeting, our commercial lawyers act on behalf the guarantor. Our lawyers review the loan and guarantee documents and explain the guarantor’s legal obligations and any potential risks. We may discuss whether liability is limited or unlimited, whether any personal assets are being offered as security, and what could happen if the borrower cannot meet their repayment obligations.
In this scenario, our lawyers act solely for the guarantor and not for the lender or borrower. After providing the advice, our lawyers sign a certificate confirming that independent legal advice was given. Lenders often require this certificate before proceeding with the loan or guarantee arrangement.
What Should Guarantors Consider Before Signing?
If you are thinking of becoming a guarantor, you should carefully consider whether you can realistically afford to repay if the borrower defaults and the debt still needs to be paid.
You should also consider whether you have been provided with sufficient financial information about the borrower and whether you understand their ability to repay the loan over time.
You should also think about whether you are comfortable exposing personal assets to potential risk and whether the terms of the guarantee can be limited or negotiated.
While many guarantees are given out of trust, family loyalty or a desire to help someone achieve their goals, a guarantor should make an informed decision based on a clear understanding of the borrower’s financial circumstances and their own potential exposure if things do not go to plan.
A guarantee should never be treated as a mere formality. It is a legally binding commitment that can have significant long-term financial consequences.
Therefore, gaining trustworthy, legal advice is an important safeguard for yourself and the financial institution lending the money to the borrower. Making an informed decision based on fact rather than emotion helps reduce disputes and supports the enforceability of the lender asking for the guarantor to pay on behalf of the borrower.
If you are thinking of becoming a guarantor for family, friends or a business colleague, contact us on 1300 003 077, where our professional commercial lawyers give you the best legal advice before signing on the dotted line.
Frequently Asked Questions
Do I really need independent legal advice before becoming a guarantor?
No always. Lenders commonly require guarantors to obtain independent legal advice before accepting a guarantee. This helps ensure you understand your legal obligations, financial risks, and what could happen if the borrower cannot repay the loan.
What does a guarantor actually agree to?
A guarantor agrees to be responsible for the borrower’s debt if the borrower defaults. For example, your friend borrows $200,000 from a bank to start a business and the bank requires a guarantor. If your friend cannot repay the loan, the lender may seek repayment from you under the terms of the guarantee. Depending on the guarantee, this can include the loan amount, interest, legal costs, recovery costs, and enforcement expenses.
Can a lender take my house or assets if I am a guarantor?
Potentially, yes. If the guarantee is secured against your property or assets, the lender may be able to enforce the guarantee and recover the debt from those assets if the borrower defaults.
Can I withdraw from a guarantee after signing?
In many cases, a guarantor cannot simply withdraw from a guarantee once it has been signed. Whether a guarantee can be released will depend on the terms of the agreement and whether the lender agrees to release the guarantor from their obligations. Therefore, it is best to obtain legal advice before signing documents.
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