Beware the Pitfalls of Signing Personal Surety

The Weekender / Business Day 20/21 May 2006

When it comes to personal surety, the biggest danger to your finances can be your wealth. Here’s how the paradox works. If you have valuable assets, banks and other lenders will be eager to ask you to sign personal surety for family members, business partners and friends who borrow money.

This means that in the event of the family member, business partner or friend being unable to pay their debts, you will be held liable.

A surety is an innocuous-looking agreement. However, if not treated with caution, it can be deadly.

Personal sureties come in various guises, with some carrying more onerous liabilities than others. Essentially they all do one thing: give the lender the right to make you pay for someone else’s debt. This is why you should read the agreement thoroughly before signing.

The Banking Ombudsman has said in the past that consumers who sign banking contracts (includes personal surety-ship agreements) without first reading and understanding them cannot expect the Ombudsman to come to their rescue.

The general rule in contract law is when you sign a contract you are presumed to know and understand the contents and so are bound by the contract.

An important point to remember about personal surety is that one size does not fit all.

Avoid people putting pressure on you by saying things like “This is our standard contract”, or “Everybody signs it”. You can and should negotiate the terms of the personal surety. Causing a delay now is better than repenting at leisure later.

Signing a surety is often not merely limited to agreeing to pay for a loan of another person should that person not be able to pay it off. Personal surety agreements often leave the amount unlimited and do not specify a date or time frame for the surety to be terminated.

The intended purpose of the surety is also more often than not left unspecified.

The results can be devastating. For example, parents often sign surety for their children’s student loans. Their son completes his degree and then wants to start his own business.

In all likelihood, the son will receive a loan from the same financial institution. A couple of years later, the new business goes bankrupt. At this stage, the parents (who are approaching retirement) get a call from the financial institution requiring them to make good their son’s business debts. This will be catastrophic on their retirement planning.

In the event of death of death or disability of a key individual within a business, creditors may become nervous about the ability of the business to repay its debts.

The creditors may then call in the debts. This could have a devastating effect on the business.

In addition, the executor of the individuals’ estate may be forced to sell of assets to meet the surety commitment. This means your family may be left high and dry, even if you took precautionary measures for their financial security after your death.

Surety cover can be taken out on the life of the key individual to prevent this scenario. These costs are tax deductible.

In the event of death or disability, the proceeds will be paid to the company’s bank account. The company will then, in terms of a contract, repay the debt and the individuals’ estate will be released from any claims.

The business pays premiums and an agreement is entered into between the business and the owner, which obliges the business to apply the proceeds to repaying the debt, releasing the surety.

Your best protection against surety agreements is to avoid signing them altogether. However, this is not always an option. Few people can buy their homes cash, and directors or partners will be required to sign sureties for business overdrafts and loans.

My advice, if you are asked to sign surety, is to contact a certified financial planner or your attorney to help you avoid the pitfalls. They can also advise you on ways to limit losses by limiting the surety.

Debbie Netto-Jonker, CFP™, is founder of Netto Financial Services and was financial planner of the year in 2001.