Here are two seemingly random legal questions that I deal with on a regular basis: Should I incorporate my business? And – Should I give a personal guarantee?
I’m going to deal with these questions out of their logical order by addressing the guarantee question now and the incorporation question in a later entry.
Well, okay, just so everything makes sense in a chronolinear fashion, yes you should incorporate your business; now let’s get on to the guarantee question.
The primary reason behind incorporating (are we on that again?) a business is to turn that business entity into a distinct legal entity that is responsible for its own debts and other liabilities. Once your accountant and your lawyer have recommended incorporation, the basic presumption is that your business is acting as a separate and distinct party in its day to day operations. And with very few exceptions (such as director liability law), the corporation itself is the extent of the liability for those operations. If the corporation makes a profit, it is up to the corporation to disperse or re-invest that profit. If the corporation loses money, it is up to the corporation to pay back that money or to make a proposal to its creditors if it cannot.
But as both public and private lenders are increasingly reluctant to lend these days, we are seeing more and more demands for the principals of a corporation to guarantee the debts that the corporation enters into. Guarantors need to think long and hard before entering in to any agreement in such a capacity. They need to understand the full extent of their exposure. They need to understand that (in most cases) they are joint and severally liable for the entire debt they are guaranteeing. And while it is obvious that this means that they are on the hook if the corporation goes bankrupt, they need to understand that there are various other scenarios where they may be liable for the debt. They need to know that the guarantee may affect their credit rating. They need to know that there may be very specific criteria in place for being released from the guarantee – I have acted for more than one person who has had a guarantee come back to haunt them years after separating themselves from the corporation that required the lending in the first place.
I would caution anyone who is considering entering into a personal guarantee, large or small, to get detailed and thorough advice on all of the ramifications before signing anything.
Coming soon – Should I incorporate my business? I’ll give you a hint – the answer might have something to do with your willingness to act as a guarantor…
Scott R. Young, LL. B.