Personal Guarantees

Exploding the Myths and Examining Your Options

General Advice Warning:  Nothing on this page constitutes financial advice nor is it a specific recommendation. Your personal situation has not been taken into account and you must seek your own legal, financial and taxation advice in determining what loan structures are best for your unique circumstances and goals.

Definitions.  While many lenders are splitting hairs on the difference between granting a personal guarantee or an indemnity, and while the difference may be legally valid, and even legally significant, we will use "personal guarantee" to mean any guarantee, indemnity or promise made by a Member of the Fund without which "personal guarantee" the lender would not be willing to make the loan to the Fund.

The amendments to the Superannuation Industry Supervision Act (SIS Act) that allow a SMSF to borrow to invest in property require very specific criteria to be met. Among these criteria is the requirement that a lender must have ‘limited recourse’. That is, the lender’s recourse in the event of default by the borrower (the SMSF) is:

1. Limited to the security property that is the subject of the loan, and
2. Must exclude any recourse to the other assets of the SMSF.

Banks being the conservative organisations that they are have traditionally ensured that they protect their capital with the best ‘collateral’ possible. Thus the notion of limited recourse is anathema to them. In desiring to strengthen their position, and given that they cannot require the SMSF to provide any further security, they have passed the responsibility on to the ultimate ‘beneficiaries’ of the loan by seeking personal guarantees from the members of the SMSF.

CLICK HERE - to provide details of your scenario so that a SMSF Loans Consultant can assist your Advisor with these considerations.

Compliance.   It has been argued that, in calling in the guarantee against the members, a path of causation could arise which in turn exposed other assets of the SMSF. This would be contrary to the legislation and thus could render the SMSF non-compliant. To avoid this situation, and in effect ‘short-circuit’ the path of causation, lenders seeking personal guarantees are asking members to enter into ‘limited guarantees’ including the granting of an indemnity that the members will not seek to access other assets of the fund should the fund become ‘delinquent’ with respect to borrowings and thus cause a claim against the members in their personal capacity.

Please Note:  Amendments to s67(A) of the SIS Act received Royal Assent on 7th July 2010.  Among other clarifications, these amendments have confirmed the position on Personal Guarantees.  The effect is that:

• Personal Guarantees are permissible, and

• The Act now clearly states that any recourse by the Trustee or any other Third Party (including Fund Members) is strictly limited to the asset that is mortgaged.

We have left the preamble to this section purely in order to provide a 'historical' context for the recent amendments.

CLICK HERE to read a copy of the Explanatory Memorandum for the amending Bill.

For more information regarding this issue, please Contact Us.

External Borrowings.  In granting personal guarantees, Fund Members should have regard to the effect that the guarantee will have on any future borrowings outside the SMSF. These impacts could include personal or business borrowings. Subsequent lenders could view the guarantee as a liability or only as a contingent liability, but in either event it will have an impact on the lender's decision making. Some SMSF lenders have developed structures to avoid personal guarantees by granting a full recourse loan to the Members of the Fund who in turn make the limited recourse loan to the Fund. It is clear that this structure must materially affect the Members borrowing capacity going forward.

Taxation.  A less commonly reported concern is that of the effect of a personal guarantee on the treatment of net proceeds from the property investment including treatment of capital gains. The concern is that the acquisition of the property by virtue of the granting of a personal guarantee may mean that it is not an “arms length” transaction and therefore may expose the SMSF to taxation at the member’s marginal tax rate as opposed to the concessional tax rates enjoyed by SMSF’s.

A copy of the Proposals Paper can be downloaded by CLICKING HERE.  Refer especially to Paragraphs 4.1.1 and 4.2.  Please note that this is a Proposals Paper only at this stage and is not yet policy. 

Please also note that this Paper was drafted prior to the clarifying amendments to s67(A) as outlined above and therefore Treasury may reconsider its position. 

CLICK HERE - to provide details of your scenario so that a SMSF Loans Consultant can assist your Advisor with these considerations.

Considerations

SMSF Loans can assist you to establish a loan with or without a personal guarantee.  We have a number of lenders who either don’t require personal guarantees or who we can negotiate with to waive the requirement, subject to the specifics of your application and scenario. SMSF Loans has been successful in negotiating a number of concessions from lenders under circumstances where customers of that very lender have been subjected to strict application of bank policy.

That being said you may ask: “Why don’t you just have loans without guarantees and avoid the whole problem?”  If only life was that simple. In seeking a SMSF Loan that does not require a personal guarantee please note that the lender is taking a greater risk and that normal lending and investment guidelines therefore dictate that they should receive a higher return.

The practical upshot is that, in order for us to negotiate a loan without a guarantee on your behalf, one or more of the following factors will likely come into play:

1. The lender may offer a lower Loan to Value Ratio (LVR) in order to reduce their exposure and offer you the same rate, fees and charges.
2. You may be required to pay a higher interest rate.  That is, higher than the rates that may be available if you were giving a personal guarantee.
3. You may pay a higher “Application Fee” or “Establishment Fee”.  Given that none of our lenders currently charge Lenders Mortgage Insurance (LMI) these increased establishment fees could be viewed as a “Credit Risk Fee” designed to offset the increased risk of a limited recourse loan.
4. You may achieve the same rate and the same LVR as you would in granting a personal guarantee, however the lender may apply a more strict servicing assessment.  This may impact the total borrowing your fund can undertake.

You will need to form your own opinion as to the cost-benefit analysis of whether or not to give a personal guarantee.

CLICK HERE - to provide details of your scenario so that a SMSF Loans Consultant can assist your Advisor with these considerations.

Advice 

SMSF Loans believes it is imperative that you take Financial and Tax advice prior to entering into a SMSF lending structure. We encourage you to raise the specific concerns above and have your adviser determine the best approach to your SMSF borrowing needs. 

SMSF Loans Consultants are only too happy to discuss these considerations further with advisers in order to ensure that our mutual clients receive the best possible outcomes.

If you are not currently working with an Adviser, please visit our Advice Page for assistance.