Trading account guarantees are like zombies

Most businesses trade with the benefit of a corporate structure. The key benefit is that a company is a separate entity and the liability of the shareholders is limited to their capital contribution (typically a nominal amount). That is, if the underlying business fails then the debts remain those of the company, not the directors or shareholders (exceptions for failure to pay super, PAYG, etc).

In theory, that sounds almost too good to be true! The reality is a little different. So, if the business seeks a bank overdraft, then the bank will insist on personal guarantees from the shareholders and directors to support the loan to the company. If the company defaults on the loan, then the bank can seek repayment from the directors/shareholders.

Many companies/businesses also obtain goods on credit from other traders. Typically, the company/business receives the goods and only needs to pay the invoice 30 days later. The terms of trade for those other traders often also seek a personal guarantee from the directors/shareholders of the company. Sometimes the request for a guarantee can be resisted, but often it can’t. For example, if you are a house painter then likely Resene or Dulux or the local trade centre will not supply their products on credit without a personal guarantee, and without paint a painter does not have a business.

Personal guarantees do not have a use by date. So long as the company has a trading account with that trader, if the company defaults the individual guarantors are personally responsible for the company’s debt to that trader. A guarantor can’t just write to the trader and say my guarantee is cancelled. The trader holds the benefit of a guarantee and it cannot be unilaterally withdrawn. That is, the guarantee lives on in some zombie like after-life and is difficult to kill off.

If a company is set up with two directors/shareholders, sometimes one decides to buy the other one out, either amicably or because of a falling out. If this occurs, often there will be a refinancing, so any guarantee to the bank will be released.

But for trading account guarantees, this can be more problematic. Perhaps the business hasn’t kept track of what guarantees have been given. Perhaps the trader is approached but refuses to release the guarantee. If this occurs, the business could continue to trade for a couple of years, rack up significant trading account debts to these traders, go bankrupt and then the trader claims against all guarantors. The person who exited the business two years earlier gets a rude surprise; he or she thinks they are long out of the business but then discover that they remain personally responsible for the company’s debts for trading when they had no interest in, or control over, the business. This issue can also arise on a sale of the whole business to a third-party buyer if it occurs by way of selling the company itself (less common) rather than all the assets comprising the business (more common).
One recommendation to deal with this is to put a use by date on the guarantee. If it is an ongoing trading account, it is a bit artificial to state that it expires in a set time (say in a year). The credit department of the trader is very unlikely to want to have to deal with ensuring that personal guarantees are regularly renewed. An alternative is to seek an amendment to the guarantee to the effect that the guarantee expires if the person ceases to be appointed as a director. A suitable clause would be:

• “This guarantee ceases to operate regarding any debts incurred after the time the guarantor ceases to be appointed as a director of the customer.”
Under this formulation, the director would be responsible for any debts incurred by the company prior to their resignation.

A broader clause, more beneficial to the guarantor but likely less palatable to the trader, is:
• “This guarantee ceases to operate after the time the guarantor ceases to be appointed as a director of the customer, including regarding debts incurred by the customer prior to that time.”

You can simply hand-write one of the above clauses into the guarantee section of the credit application and initial the change. Be sure to retain a copy.

Absent something peculiar in the company’s constitution, and assuming it is not a single director company, the resignation of the outgoing director is effective upon the resigning director giving written notice to the company. The resignation does not require acceptance by the company.

Be sure to inform ASIC of your resignation. If the exiting director does not have the corporate key for the company (allowing the lodgement of electronic notices with ASIC), the director should lodge a paper form 484 with ASIC notifying ASIC of their resignation accompanied by their letter of resignation (as permitted by Corporations Act s205A).

As a final tip, try to keep track of the guarantees that have been provided. Then their release, absent a clause as suggested above, can be sought in an orderly manner, upon a resignation or sale situation.
Failing all else, and whilst not necessarily effective, the resigning director should write to all traders who hold his or her guarantee and inform them of their resignation and saying the guarantee is withdrawn for all trading by the company with that trader from that time forward (asserting that any goods supplied after that time is done so without the benefit of that person’s guarantee).

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