The landscape of Self-Managed Super Fund (SMSF) lending has witnessed a contentious trend: the increasing prevalence of personal guarantees.
Unfortunately, many brokers and SMSF trustees lack a comprehensive understanding of the implications associated with personal guarantees. In this article, we explore the nuances of personal guarantees, their significance, and the considerations for SMSF borrowers.
What Is a Personal Guarantee?
A personal guarantee involves an agreement between the borrower (typically the SMSF) and the lender (often a bank or financial institution). Under this arrangement, an individual guarantor (usually an SMSF member or a third party) pledges to guaranteeing a loan, thereby assuming responsibility for the debt in the event that the SMSF fails to meet its obligations.
If the SMSF defaults on the loan and the property secured by the loan is subsequently sold, the lender has the legal right to recover any shortfall from the guarantor. This shortfall represents the difference between the outstanding loan amount and the proceeds obtained from the property sale.
A personal guarantee is sought by the lender because the lender's ability to recover funds is restricted to the specific property acquired through the Limited Recourse Borrowing Arrangement (LRBA). Other assets within the SMSF remain protected from such claims.
Personal Guarantees in SMSF LRBAs
1. Legality and Clarification
Dispelling the Myth: There was once a misconception that SMSF members could not provide personal guarantees. However, amendments to section 67(A) of the Superannuation Industry (Supervision) Act (SIS Act) clarified that personal guarantees are indeed permissible.
Limited Recourse Protection: Any recourse under a personal guarantee remains confined to the specific asset (typically the property) mortgaged within the LRBA.
2. Purpose and Mechanism
Enhanced Security: By offering a personal guarantee, an SMSF member or a third party provides additional collateral for the loan.
Default Scenario: If the SMSF fails to meet its repayment obligations, the lender can seek recovery from the guaranteed assets, specifically the LRBA-acquired property.
3. Compliance and Documentation:
Clear Documentation: Properly documenting the personal guarantee is essential. This ensures that the SMSF genuinely borrowed funds for the LRBA asset, preventing the related-party contribution from triggering unintended tax consequences.
Ongoing Compliance: SMSFs must continue adhering to other legislative requirements, including the sole purpose test and investment restrictions (such as those related to in-house assets and acquisitions from related parties).
4. Lender Practices:
While the law permits related parties to act as lenders, the Australian Taxation Office (ATO) closely scrutinises related-party LRBAs.
The loan terms and ongoing operations must align with what an arm’s-length lender would typically accept for a similar borrowing by an SMSF trustee.
Considerations and Waiving the Guarantee
1. Lender Discretion:
Not all lenders insist on personal guarantees. Their approach varies, and discretion plays a role.
2. Opting Out of the Guarantee:
Negotiating the limitation of the personal guarantee is possible. Factors include the Loan-to-Value Ratio (LVR), SMSF balance, and contributions.
3. Seek Professional Advice:
Specialist credit advice, along with accounting and tax guidance, is crucial when navigating personal guarantees.
Key Takeout
In Self-Managed Super Fund (SMSF) lending, SMSF members have the option to offer personal guarantees for SMSF loans. Notably, there exists a growing trend where lenders increasingly rely on personal guarantees in SMSF loan arrangements.
As this trend persists, borrowers should exercise due diligence and seek specialist advice from professional advisors to navigate the implications of personal guarantees effectively.
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