Michelle explained in an earlier post that many small business owners choose to incorporate their business to protect themselves from personal liability from the obligations of the business. The corporation has its own separate legal identity from the corporation’s directors and shareholders. For example, a supplier can demand payment for unpaid goods from an incorporated business but not directly from the directors of that business. The corporation has the obligation, not the corporation’s directors or shareholders. The corporation’s directors and shareholders are protected behind the “corporate veil.”
There are times, however, when the corporate veil is pulled aside and the directors or shareholders (or both) can be made liable for the corporation’s obligations. One such instance often occurs when a small, closely-held corporation needs to borrow money from a bank.
Banks are well aware that a corporation and its directors have separate legal identities and, therefore, if a corporate borrower fails to pay its loan back, the bank has no legal ability to demand payment from the directors and shareholders. It will come as no surprise that an ingenious workaround has been developed to ensure that banks can get their money back; it’s called the personal guarantee.
In addition to other security a bank may demand (such as a mortgage on corporate real property or a security agreement on corporate personal property such as equipment or inventory), the bank may require a personal guarantee. That is, the bank requires someone (the “guarantor”) to guarantee the loan, in the event that the corporation fails to pay the loan back (although the bank usually doesn’t need to wait until the corporation defaults to seek payment from the guarantor).
These guarantees strip away any protection that the individual person would have otherwise had against this financial obligation of the corporation. Signing a personal guarantee for a corporate loan is a personal acceptance of that corporate obligation and represents a significant legal and financial decision for the guarantor.
In Alberta, the government wants to ensure that people who sign a guarantee fully understand the nature and effect of the document. As such, we have provincial legislation called the Guarantees Acknowledgement Act that governs the proper signing of these guarantees. The Act requires that a Notary Public personally meet with the person who has signed the personal guarantee and confirm that the person is aware of the contents of the guarantee and understands it. A certificate confirming this is completed and attached to the personal guarantee. The certificate is intended to demonstrate that the guarantor has accepted the obligations knowingly and willingly.
The decision to personally guarantee your corporation’s loan is a significant financial, legal and personal decision. At Patriot Law Group, we can answer the legal questions you might have about running your small business, including questions about personal guarantees.