Lending money is risky business
Lenders are in the business of making money by lending money to businesses and individuals. This means that they need to be very sure that they will be repaid the loan and interest from each lending transaction.
The reality is that every time they loan money, they risk losing it. The future is unpredictable and there is no guarantee that the borrower’s circumstances won’t change (they could lose their job or the business could fail).
Lessening the risk
One of the ways lenders can lessen the risk of lending money is to insist that business owners or individuals borrow money and provide surety for the loan. Surety is a third party who promises to pay the money back even if the business or individual goes into bankruptcy - it is a guarantee. The common terminology used by the financial sector is to say that someone “stands surety” for the loan.
Types of surety
All the lender wants to know is that they are guaranteed not to lose the money (and interest) that they lend you. You have a few options to choose from in order to provide surety for the loan:
- Sign personal surety (where you are fully responsible for repayment of the loan and interest, and the lender can attach and sell any of your personal assets in order to recoup their money).
- Find a relative or friend to sign surety against your loan (where the friend or relative becomes personally liable to repay your debt - loan, interest and admin charges) in the event you default.
- Raise sufficient collateral so that you don’t need to sign surety.
The information below is going to cover the extremely broad powers that the lender has over your assets if you sign personal surety. Please ensure that you fully understand the consequences of signing personal surety and, if at all possible, avoid signing these documents.
Key features of personal surety
Surety to make sure you know how best to protect yourself. Personal surety documents are legal documents full of terms that can be confusing to the layman. So, we are going to start off by explaining some of the key terms you are likely to encounter in a personal surety document.
Joint and several liability
You might have business partners, where more than one of you owns the business. In this case, the lender will make certain that the surety is signed by yourself and your business partners. Joint surety is designed in such a way that all of the business owners are “jointly and severally liable” in their personal capacity. This means that if the business doesn't pay back the loan, the lender can come after any (or all) of the business owners to claim back the full amount owed by the business.
The real snag here is that each partner is signing surety for the FULL amount of the loan, plus interest and administrative costs. This gives the lender the right to decide whether to claim the amount from all partners, or from an individual partner, irrespective of their shareholding in the company.
It pays to remember that business is not about emotions. As a result, the lender will look to find the easiest and most cost-effective way to recover the money. This means that they will attach the assets that are the easiest and simplest to sell.
To summarise, the term "jointly and severally" allows the lender to go after the partner who is most accessible, and who can pay back the loan with the least legal complications.
This strange word means that the lender must first try to get their money back from the principal debtor (that is, the business or person who signed the loan agreement) before they can turn to you to honour the debt. So essentially, the lender must attach and sell the business assets, before they can attach and sell your personal assets.
However, a standard personal surety contract will generally have a clause in it that says if your business fails to repay the loan, the lender can get the money back from you and furthermore, the lender can do this in whatever way is easiest for them. In other words, the lender doesn’t have to first try to recover the money from your business assets, they can go directly to your personal assets. That means that they can take away your house first if that is the easiest way to recover their money! In legal terms, you sign away the rights to the “benefits of excussion”.
Generally, in South Africa, personal surety contracts are unlimited. This means that the surety applies to the specific finance contract you have negotiated AND any future money you or the business (in the case of a business loan) might owe that lender.
The surety is considered unlimited (in relation to time), meaning it never ends, even when you have completely paid back the lender.
Did you know that unlimited personal surety means that you are FOREVER responsible for repaying the debts of the company even if you sell the company?
So the key message is this: refuse to sign unlimited surety agreements. If you have to sign personal surety for a loan, then make sure that the surety is limited to that specific loan, and is cancelled when the money for the loan has been repaid.
How to minimise your risk
The reality is that most business owners will have to sign for personal surety if they want the money. If you are considering signing personal surety, make sure you have a professional advisor look over the document and help you set limits that protect you and your assets.
Here are some tips on how to minimise your risk:
- Make sure the document clearly states that the amount of money is limited to the loan amount.
- The document must contain a clause that states that it is only valid for the duration of the loan period.
- Always keep copies of all the surety documents you sign.
- Keep track of loan repayments and correspondence.
- Once the loan has been repaid, make sure you receive written confirmation that the surety has been cancelled. You may need to really push to receive it, but it is worth the effort. Attach this document to the personal surety contract and keep it safe.
Keep your assets safe
- One of the ways to keep your assets safe is to form a trust and then transfer the assets to the trust. However, this can be costly for early-stage businesses. Keep it in mind for the future if you cannot afford it now.