Quick answer
A contingent liability is a possible obligation that only becomes a real debt if a future event happens. The classic business example is a personal guarantee: you owe nothing until the borrower you guaranteed defaults. Lenders ask about contingent liabilities because guarantees, bank guarantees and pending legal claims could land on you without warning, reducing the income and assets available to repay a new loan.
Key points
- A possible debt that depends on something that hasn't happened yet
- Guarantees you have given are the most common example for owners
- Usually disclosed in notes to the accounts rather than on the balance sheet
- Lenders may count some or all of a guaranteed debt when assessing serviceability
Think of a contingent liability as a debt waiting in the wings. Today it costs you nothing and may never cost you anything. But if a particular event occurs, such as a borrower defaulting or a court ruling going the wrong way, it steps onto the stage as a bill you must pay.
Common examples for Australian business owners
- Personal and director guarantees. Guaranteeing your company’s loan, a family member’s business loan or a supplier’s trade account.
- Lease guarantees. Landlords commonly ask directors to guarantee the tenant company’s rent and make-good obligations.
- Bank guarantees. Your bank promises to pay a landlord or customer if you don’t. The bank holds security, often a term deposit or property, which it can call on.
- Legal claims and disputes. A customer suing over faulty work, or a contract dispute not yet resolved.
- Tax exposure. An open ATO audit, or unpaid PAYG withholding or super that could lead to a director penalty notice making directors personally liable.
The accounting rules are set out in AASB 137. In short, a contingent liability is disclosed in the notes to the financial statements rather than recorded as a liability, unless an outflow becomes probable and can be measured reliably.
Why lenders want to know
A lender assessing a new loan is asking one question: can this borrower comfortably repay us? Guarantees and claims can change that answer overnight, so most applications include a statement of position asking you to list them.
Different lenders treat them differently. Some will add the full guaranteed amount to your debts. Some apply a partial loading. Others look at the main borrower’s track record and ignore a well-performing guarantee entirely. That alone can explain why one lender says no and another says yes on the same figures.
Unsure how your guarantees will be viewed? Send us a brief enquiry and we’ll tell you honestly.
Worked example
Sam owns a Perth plumbing company and wants a $200k loan against an investment unit to buy two new vans and expand the team. On the application, Sam lists:
| Contingent liability | Amount |
|---|---|
| Director guarantee on the company’s existing equipment loan | $90k |
| Guarantee of a sibling’s café lease (rent for the remaining term) | $150k |
| Pending dispute with a builder over a disputed invoice | Uncertain |
The equipment loan has never missed a payment, so the lender is relaxed about it. The café lease is the bigger concern, since Sam has no say in how that business is run. The lender asks for the café’s recent trading figures and a copy of the lease, and requests a note from Sam’s accountant about the builder dispute.
Because everything was disclosed at the start, the lender approves a slightly reduced $180k. Had the café guarantee turned up later in a credit search, the deal may have fallen over entirely. You can test how extra commitments change the numbers with our borrowing power calculator.
Related terms
See personal guarantee, director guarantee, guarantor, serviceability and net worth. Our guide on business loans and personal guarantees goes further.
Guarantees in the background? Let’s look at the whole picture
Owners often worry that old guarantees will sink a new application. Sometimes they matter; often they matter less than people fear, and the right lender makes the difference. Telling us about your situation is roughly a sixty-second job, and your credit report stays untouched. We keep your details in-house instead of firing them off to a crowd of lenders, and one of our people reviews what you’ve told us before giving you a call. Mention every guarantee and claim, even small ones, so we can bring you an option that will hold up when the lender checks.
Frequently asked questions
Is a personal guarantee a contingent liability?
Yes. While the borrower you guaranteed keeps paying, you owe nothing. If they default and the lender calls on the guarantee, it becomes an actual debt that you must pay.
Do I need to disclose contingent liabilities on a loan application?
Yes. Most applications and statements of position ask for guarantees and other contingent liabilities. Leaving them out can lead to a decline later, or a breach of the loan agreement if discovered after settlement.
Does a contingent liability go on the balance sheet?
Under Australian accounting standards it generally doesn't appear as a liability on the balance sheet. It is disclosed in the notes unless payment becomes probable and can be measured, at which point it is recognised as a provision.
Will a lender treat a guaranteed debt as if it were mine?
It varies. Some lenders include the full guaranteed amount in their calculations, some include part of it, and others look at how well the main borrower is paying. A strong repayment record on the guaranteed loan helps.
How can I reduce my contingent liabilities?
Ask to be released from guarantees you no longer need, for example when you leave a business or a lease ends. Refinancing the guaranteed loan into a structure that doesn't need your guarantee can also remove it.