The dangers of personal guarantees

By Dean Claughton

The best laid plans of mice and men can go astray – this is never more true than in the world of business, particularly when it comes to giving a personal guarantee for your premises.

A decision in the NSW Supreme Court (Padstow Corporation v Fleming, 2013) highlights the dangers of personal guarantees for directors of companies, and shows that if you’re a tenant, you should offer a higher bank guarantee/security deposit, rather than providing personal guarantees.

The case also serves to illustrate that tenants should read the lease and abide by its conditions. It became evident in this case that the tenant was not aware of the provisions of the lease, and this came back to haunt the tenant after the lease had been terminated.

As a pharmacist, reading and understanding the lease is especially important, as it may contain clauses dealing with approvals from Medicare and the Pharmacy Board of Australia – clauses that can have major implications on your business if you fail to comply with them.

So, what happened in the case of Padstow v Fleming?

Padstow leased premises to Fleming from 2004 for a term of eight years. Under the terms of the lease, personal guarantees were required from the directors of the tenant company, unless Fleming provided a bank guarantee/security deposit in the sum of three months’ rent.

Unfortunately for Fleming, the company failed to provide the security deposit/bank guarantee in lieu of the personal guarantees. Therefore, the directors were taken to have given personal guarantees – holding them personally liable for the obligations of the company. Essentially, this meant Padstow could pursue the directors’ personal assets to cover any losses sustained by Fleming.

During the lease, Fleming went into liquidation and the company was dissolved. As a consequence, Padstow suffered significant losses – not only did it lose a tenant, but it was also unable to lease the site to a new commercial tenant for some time. Hoping to recoup its losses and enforce the personal guarantees, Padstow took the directors of Fleming to court.

The directors of Fleming argued that the extent of their personal liability should be limited to the equivalent of the bank guarantee/security deposit that should have been provided under the lease – the three months’ rent that was never paid.

The judge decided that this argument was flawed and defeated the purpose of the personal-guarantee provisions contained in the lease. The directors of Fleming were held jointly responsible for Padstow’s losses and were forced to pay from their own pockets.

What does this mean for you?

In short, avoid personal guarantees at all costs. If a landlord is insisting on personal guarantees being given, it may be worth your while to negotiate a higher bank guarantee/security deposit, instead of providing a personal guarantee.

If this negotiation tactic doesn’t work with the landlord, another tactic is to limit the liability of the personal guarantee. For example, if the landlord is insisting on a personal guarantee, determine whether you can limit that guarantee to a set sum (possibly in the vicinity of two or three months’ rent). If this is agreed to, at least you know how much you may be up for, rather than being subject to the scary scenario that you are providing a personal guarantee with an unlimited value.

Another point this case raises is that you really should be aware of the provisions of the lease – reading it thoroughly before signing on the dotted line. In this case, it was blatantly obvious that the directors of the tenant company were not aware of the provisions of the lease, otherwise they would have realised that giving a three-month bank guarantee/security deposit was far better than providing a personal guarantee with unlimited liability.

Pharmacists should also take into account that their lease should be conditional on receiving the approval of both Medicare and the Pharmacy Board. All pharmacy leases are required to be approved by these two governing bodies, and where a lease is not approved, the business may be closed down.

Therefore, it is essential to be able to terminate your lease, with no compensation payable to the landlord, if you don’t receive these approvals.

Although most sophisticated landlords will be aware of the need to be registered with Medicare and the Pharmacy Board, it is still worthwhile having this discussion with the landlord or their representative. You don’t want to be in the position of having a signed lease and then not receiving the necessary approvals, as you may be bound by the lease for the rest of the term, even though you can’t run your business from the premises.