Personal Guarantee: Why Business Owners Sign It Without Understanding the Implications

1. A personal guarantee given to a bank must be limited in amount. An unlimited guarantee given by a “sole guarantor” (one who has no interest in the company) is void pursuant to the Guarantee Law, 5727-1967.
2. A controlling shareholder in a company who signs a personal guarantee for the company’s debts does not enjoy the same protections that the Guarantee Law grants to a “sole guarantor.” The reason: the law excludes from the definition anyone who is a “person with an interest” in the corporation.
3. Even without a signed personal guarantee, a controlling shareholder who managed a company while misleading creditors, transferring assets fraudulently, or taking unreasonable risks may be required to pay the company’s debts from his personal funds, pursuant to piercing the corporate veil.
4. The bank is required to disclose to the guarantor material details regarding the debt before signing, and failure to disclose may, under certain circumstances, exempt the guarantor from part of his obligation.
5. A guarantor who has fulfilled his guarantee and paid the debtor’s debt is entitled to seek recourse against the debtor and recover from him what was paid, plus expenses and interest.

Why Personal Guarantee Is One of the Greatest Risks in Business Life

A limited liability company is founded on one central principle: limitation of liability. The shareholder is only liable to lose his investment in the company-nothing more. However, in actual business life, this principle dissolves the moment the business owner signs a personal guarantee.

The bank, the supplier, the landlord-each of them may demand a personal guarantee as a condition for doing business with the company. Often, the request comes as a “formality”-“just a form, everyone signs.” But when the company encounters difficulties, that form becomes a direct claim against personal assets: the apartment, pension savings, the bank account.

Three Types of Guarantors and the Critical Difference Between Them

The Guarantee Law, 5727-1967, distinguishes between several types of guarantors, each with a different degree of protection.

Sole Guarantor: One who is not a corporation and is not a spouse, partner, or person with an interest in the debtor company. For example: a friend who provides a personal guarantee for a friend’s business. Such a guarantor is afforded far-reaching protections: the guarantee must be limited in amount, the creditor must disclose material details to him before signing, and failure to disclose may result in partial exemption.

Protected Guarantor: A sole guarantor whose guarantee amount does not exceed a certain threshold set by law (approximately 89,000 shekels as of this date, or up to approximately 744,000 shekels for a guarantee for a residential mortgage). A protected guarantor receives additional protections: he cannot be sued before collection proceedings against the principal debtor have been exhausted.

Person with an Interest in a Corporation: One who is defined as a “person with an interest” under the Securities Law. In simple terms: a significant shareholder, senior officer, partner. The law applies only limited protections to such a guarantor. He signed with full knowledge of the company’s risks, and the court will act accordingly.

What the Bank Must Disclose Before You Sign

Pursuant to the Guarantee Law and Section 22 thereof, the creditor is required to disclose to a sole guarantor, before signing, material details pertaining to the debt: the amount of credit, its terms, whether the guarantee can be rolled over to additional debts, whether there are additional securities, and more. The creditor is also required to provide the guarantor with a copy of the guarantee agreement and to give him a reasonable opportunity to review it before signing.

The Supreme Court held in CA 1750/92 United Mizrahi Bank Ltd. v. Prof. Zvi Ziegler (PD 49(1) 369) that the bank is obligated to provide proper and active disclosure to the guarantor-not merely to answer questions, but also to initiate and explain. In CA 7451/96 Avraham v. Bank Massad (PD 53(2) 337), the court extended this duty to changes in the status of the debt during the guarantee period.

Piercing the Corporate Veil: When the Company Bears the Debt but Its Owner Pays

Even without a signed guarantee, a controlling shareholder may find himself personally liable for the company’s debts. This occurs when the court is willing to “pierce the corporate veil” and disregard the separate legal personality of the company.

The Companies Law, 5759-1999, Section 6, permits this in two principal situations: use of the company’s legal personality in a manner that involves defrauding a person or prejudicing a creditor, or in a manner that undermines the company’s purpose while taking unreasonable risk in relation to its solvency when the shareholder was aware of this.

It is important to emphasize: piercing the veil is not an automatic tool. In a case represented by our firm (LC 32871-05-13 Kaufman v. Barosh et al.), the Labor Court held that attributing personal liability to controlling shareholders in a company requires individual examination of each defendant separately, and one cannot rely solely on the fact of being a shareholder. The court rejected most of the claims for piercing the veil and attributed personal liability only after finding specific evidence that the defendant abused his position.

Anecdote: When the Nephew Signed Knowing the Company Could Not Pay

An article on the Mako portal documented a case in which an owner and his nephew jointly managed a meat packaging company. After checks began to bounce, they explained to the supplier that it was a “minor cash flow problem.” The nephew even signed a personal guarantee to the supplier despite knowing clearly, like his uncle, that the company would not be able to meet its obligations. The court ordered the business owner to pay approximately 600,000 shekels from his personal funds. The message: a personal guarantee signed with knowledge that it cannot be honored may constitute evidence of bad faith that weighs heavily in legal proceedings.

In a case represented by our firm (CA 41336-11-19 Chuck Bass Ltd. v. Y. Solomon Experience in Utensils Ltd. et al.), a personal guarantor attempted to characterize the creditor’s demand to comply with the agreed credit facility as “extortion,” claiming he had never committed to the terms agreed between the creditor and his company. The court rejected the claim: the guarantor himself admitted in cross-examination that he had heard from the creditor’s manager the amount of the agreed credit facility. A guarantor who is proven to have known of the obligation cannot later hide behind it.

What to Check Before Signing and What to Try to Change

Before signing a personal guarantee, several important questions to ask:

Is the amount limited? An unlimited guarantee given by a sole guarantor is void under the law. Even one who is not defined as a sole guarantor may attempt to negotiate a limitation on the amount.

Is the guarantee revolving? A “cumulative” guarantee that covers future debts and is not limited to a specific debt is a particularly dangerous guarantee. One should demand limitation to a defined debt.

What are the other securities? If the creditor has proprietary securities (lien, mortgage), priority of collection from them should come before recourse to the guarantor.

What happens if the company encounters difficulties? It is advisable to know in advance: will the guarantee apply even in insolvency proceedings? How much time does the creditor have to approach the guarantor?

Negotiating the terms of the guarantee before signing is the proper tool. After signing, the options narrow.

Are you about to sign a personal guarantee, have you received a demand to enforce a guarantee you signed in the past, or is your employer about to abandon ship and you are concerned that debts for which you are a guarantor will be written off? It is advisable to examine the situation before reaching the point of no return.

© Tidhar Tzur Law Firm | This article is for general information only and does not constitute individual legal advice.