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Most small businesses start off as sole traders (just the person operating the business). At that stage, the businessperson is responsible for all the debts of the business, without exception. Later, the business is transferred to a company or perhaps it even starts off as a company. A company is a separate legal person from its directors and shareholders, even though they may be the same people.

If someone deals with a company the company will have liability. The company's director will not be liable if he or she complies with the Companies Act 1993 and does not step outside the protection of the company by undertaking

something personally. Therefore, it is critical that the director always acts "as director" or "on behalf of the company and not in my personal capacity". Shareholders will never be liable beyond the money they have contributed as shares in the company. In brief, a company gives limited liability and shields its directors and shareholders from liability. So far so good-but the company may only have $1 as share capital so those dealing with it are dealing with a so-called "shell company". How do they get some substance into the relationship?

The answer is - through a guarantee. Like land contracts this is one of the few contracts which has to be in writing. Under it, someone other than the company undertakes to perform its obligations if it fails to do so. A true guarantee is a bit like an insurance policy - if there is a failure to perform someone else sees that the party holding the guarantee suffers no loss. As a guarantee is a contract it requires consideration, the legal glue which makes an obligation binding. Quite often in bank guarantees this is expressed in the following way: "You, the bank, are lending my company some money. This is a benefit to my company. Because of this I will give the bank a guarantee, because I am getting some indirect benefit from the deal". Other times, the existence of consideration is less clear. The guarantee is often executed as a deed. This is a document where the witness to the signature writes his or her name, address and occupation. Signed in that way no consideration is necessary. Illogical and legal magic but it works.

The key point of a guarantee is that demand first has to be made on the primary debtor (such as the company) and only if it fails to pay than the guarantee be called up. However, like an insurance policy, if there is any change in the underlying basis on which the guarantee was given it will not be enforceable. For example, if the relationship between the bank in the company changes or one-party waives its rights or if there is some other such alteration the enforceability of the guarantee becomes suspect.

For these reasons the guarantees contain a lengthy list of exclusions for such changes. Usually, they go further and convert the guarantee into what is known as an indemnity. This is much closer to an insurance policy than a guarantee and essentially means that the person giving the "guarantee" is undertaking personally and directly to the person holding the guarantee as if he or she were in a direct relationship with it. A common example is the bank guarantee. The director or shareholder giving a guarantee will effectively be promising directly to the bank that if the bank wants to, it can make demand for repayment of the loan directly to the person without even first approaching the company.