Introduction

A limited company has a separate legal entity from its owners. The owner’s personal assets are not usually at risk if the company fails. At certain points in a company's life, such as its inception or when it needs additional capital to expand, bank lenders or suppliers will look at the viability of the business when deciding whether to lend or supply goods. If they consider that there is an unacceptable risk they will look to the shareholders or directors to provide personal guarantees.

While personal guarantees can unlock opportunities, they also expose guarantors to significant personal risk. As a business owner, partner or director, understanding your legal position and taking precautionary steps is crucial before signing any such agreement.

What is a Personal Guarantee?

A personal guarantee is an agreement between a business owner and/or director and a lender, typically a bank, microfinance, Sacco or any other financial institution. A personal guarantee states that the individual is responsible for repaying a loan made to the business, should the business ever be unable to do so. Personal guarantees are commonly required from business owners, directors or partners, especially in SMEs or start-up businesses, where the business may not have an established credit history or sufficient assets to secure a loan.

This type of guarantee is usually issued to provide additional security and comfort to the lender that in the event of default, it can either choose to pursue the borrower or the guarantor.

A personal guarantee is therefore a promise from the borrower to the lender that if the business is unable to repay the money, the director will be personally liable for the debt. This means that if the business is unable to repay the debt, the lender can pursue the owner's or the director’s personal assets, such as their home, car or savings to recover the amount owed.

Types of Personal Guarantees

1. Unlimited Personal Guarantee: In this guarantee, the amount is not capped and the guarantor is liable for the full amount of the debt including any interests accrued.

2. Limited Personal Guarantee: This type of guarantee limits the guarantor's liability to a specific capped amount or percentage of the debt. This is common practice where there are joint guarantees for instance each director may limit their own liability to a percentage of the debt.

Risks of signing a personal guarantee

While signing a personal guarantee can help a business secure financing or negotiate better terms, it comes with substantial risks. Here are some key risks to be aware of:

1. Personal Financial Exposure

The most obvious risk is the potential loss of personal assets. If the business fails to meet its financial obligations, the lender can seek repayment from the individual who provided the personal guarantee. This can include claims against your home, savings or other personal assets, which may leave you financially vulnerable.

2. Unlimited Liability

In many cases, personal guarantees are “unlimited,” meaning you are responsible for the full amount of the debt, plus any additional interest, penalties, or legal costs. This exposure can be particularly damaging if the company’s financial troubles are severe or long-lasting.

3. Impact on Credit Rating

If the business defaults and you are required to make payments under the personal guarantee, your personal credit rating may be negatively impacted. This can affect your ability to secure future loans or credit, both for personal and business-related purposes.

4. Potential for Legal Action

The lender could initiate legal proceedings to recover the debt which could result in court judgement or other enforcement options.

How to Protect Yourself

Personal guarantees carry significant risks; here are some ways to mitigate these risks and protect yourself:

1. Negotiate Limited Guarantees

Try to limit your liability to a specific amount or percentage of the debt. This can reduce exposure in the event of default.

2. Request a Time Limit

Seek to include a term specifying how long the guarantee will last. Without it, the obligation may continue indefinitely.

3. Insist on Notification Rights

Ensure the guarantee includes a clause requiring the lender to notify you of defaults or changes in the credit terms.

4. Add Exit Clauses

If you plan to step down as a director or sell your interest in the business, ensure the guarantee provides for your discharge upon such events.

5. Seek an Indemnity from the Company

If you are a director or shareholder, consider entering into an indemnity agreement with the company, so it agrees to reimburse you in case the guarantee is enforced.

6. Seek Independent Legal Advice

Always obtain legal advice before signing. This is particularly important because under Kenyan common law principles, courts are more likely to uphold guarantees that were entered into with the benefit of independent advice.

Conclusion

Never take signing a personal guarantee lightly. Understanding the legal and personal risks is crucial in Kenya's business environment, where many lenders require personal guarantees before granting credit. You can safeguard yourself while advancing your business or investment objectives by negotiating fair terms and getting legal counsel.

How we can assist you

At CM SME Club, we provide you with strategic legal advice, tailored contracts, and risk mitigation strategies to protect your business relationships.

Contact us today (law@cmsmeclub.com) for all your legal matters.

Written by: Magdaline Njeru (mnjeru@cmadvocates.com).

Published on July 31, 2025, 10:49 a.m.