Directors’ Personal Guarantees During Liquidation
Directors’ personal guarantees act as security provided by the director of a business for company borrowing. A diverse range of lenders may ask for a personal guarantee to be signed to give them the additional protection that, if the company cannot afford to repay the liability, they will be able to recover the debt from the director personally.
Being asked to sign a director’s personal guarantee is quite common, particularly when dealing with long-term liabilities such as:
- Business loans from the bank
- Bank overdrafts
- Commercial rents
- Property loans
- Lease agreements
- Trade supply deals
- Invoice financing and other lines of credit
While it undoubtedly adds risk to your financial arrangements, agreeing to sign a personal guarantee will improve the finance routes available to a limited company, which can be very attractive for directors who need funds to grow their business. When the business is performing well, it’s easy to assume that the lender will never have any reason to call on that guarantee. However, with business failure rates high, particularly among newer businesses, that assumption can often be misguided.
What does it mean to sign a personal guarantee?
One of the primary benefits of turning a business from a sole trader or partnership into a private limited company is the protection provided by limited liability. That keeps the finances of the business and the people who run it separate so the debts accrued the business are not the responsibility of the directors personally.
By signing a personal guarantee, a company director effectively waives their right to limited liability protection for that debt. If the company becomes insolvent and enters into liquidation, the other unsecured debts of the business will die with the company, but the lender with the personal guarantee will be able to pursue the director for full repayment of the debt from their personal funds. That could potentially put personal assets such as vehicles, property and even assets that are jointly owned with close relatives at risk.
What happens to directors’ personal guarantees during liquidation?
If a business has become insolvent and it cannot be saved, it will enter into insolvent liquidation. When a company is liquidated, all its assets are sold and the proceeds are distributed to the company’s creditors as full or part payment for the debt.
It’s often the case that the company’s creditors only receive a proportion of the money they are owed on liquidation. However, if a debt that’s been secured by a personal guarantee is not repaid in full, the creditor can then pursue the director(s) who signed the guarantee personally for the remainder of the debt.
While you might assume that the insolvency practitioner who has been charged with liquidating your company will be a good source of advice in this scenario, in reality, they may be little or no help. Although they may have a duty of care towards you as a director, they are appointed to act on behalf of the creditors. That means they’ll actually be working in the best interests of the lender you have given the personal guarantee to.
The extent to which your personal savings and assets will be at risk depends on the kind of personal guarantee you have signed. For that reason, it’s important you understand the risks involved and the potential outcomes before entering into any arrangement where a personal guarantee is required.
What’s the difference between an unsecured and secured personal guarantee?
- Unsecured personal guarantee
An unsecured personal guarantee is not tied to any specific asset. If there is an insolvency event such as liquidation and the company cannot afford to repay the loan, the lender will become an unsecured creditor of the business. That means they will be treated just like any other unsecured creditor and will have to wait in line to receive the money they are owed from the sale of the company’s assets. If any of the debt remains unpaid following the company’s liquidation, the creditor can then pursue the director personally.
- Secured personal guarantee
In some circumstances, a lender may require a specific asset to support the personal guarantee. This is usually by way of a fixed charge over the director’s home, but it could also be as a debenture on company assets or a floating charge, which will become a fixed charge when the company runs into financial difficulties or enters liquidation. If it has a secured personal guarantee, the lender can forcibly sell the asset the loan is secured against to recover the money it’s owed if you or the company cannot afford to repay it.
What steps will a creditor take to call in a personal guarantee on liquidation?
If a lender with a personal guarantee has not been repaid in full following the liquidation of the company, the next steps they take may vary depending on the value of the debt and the type of creditor they are. However, the typical routes include:
- Issue a statutory demand and begin bankruptcy proceedings if necessary
Typically, the first step a creditor will take is to issue a statutory demand. That will give you 21 days to either reach an agreement to pay the debt or to settle the debt in full. If you do not have the personal funds to settle the debt or to reach a repayment agreement, the creditor may choose to commence bankruptcy proceedings if the debt is over £5000, which it usually will be in the case of a personal guarantee.
- Apply for a County Court or High Court Judgement
The other route the creditor might choose to take is to apply for a County Court or High Court Judgement. If you are unable or refuse to pay the CCJ, the creditor can then apply for a writ of execution, which gives bailiffs the power to visit your home to seize goods that they can sell to recover the debt. Alternatively, they could apply for a charging order which will secure the debt against your home.
A charging order does not necessarily mean you’ll have to sell your property. If a creditor wants to force the sale of your home, they will have to apply to the court for an order for sale. However, it does mean that if you do sell your home, your creditor must be repaid from the proceeds.
Potential problems with personal guarantees when threatened with liquidation
If your company has been issued with a winding up petition by an angry creditor, a director who has signed a personal guarantee for the debt must be careful how they respond. The temptation might be simply to repay the creditor using company funds to prevent the company’s liquidation. However, any director who repays a specific creditor or group of creditors ahead of other creditors will have made a preferential payment.
Making a preferential payment before entering into a formal insolvency procedure such as administration or liquidation can cause serious problems for the director in question. That includes personal liability for company debts and even disqualification from acting as a company director for a period of up to 15 years.
When can directors’ personal guarantees be called in?
Company directors should be aware that it’s not only on liquidation that personal guarantees can be called in. It’s often written into finance agreements that a company may only need to have a County Court Judgement (CCJ) registered against it or for it to fail to follow the terms and conditions of the loan for personal guarantees to be called upon. ‘Insolvency clauses’ are also common, which allow lenders to recover a debt as soon as it becomes evident that the business is struggling.
Banks, in particular, reserve the right to call in personal guarantees at any time. If a company is running into financial difficulties, a bank will often take the step of converting the unpaid business debt into a personal loan. The debt can then be repaid from income earned by the director following the company’s insolvency or through the sale of personal assets.
Can you get out of a personal guarantee?
It’s not unheard of for a company director to negotiate their way out of a personal guarantee. However, the process can be difficult and lenders will not always be willing to cooperate, particularly if they are still owed money and they suspect that your business is struggling. The healthier the financial position of the company is, the greater your scope will be to reduce your liability under a personal guarantee. If you wait until the business is approaching insolvency, then the likelihood of success be slim.
If you hope to negotiate your way out of a personal guarantee, you should start the discussions as early as possible. You must have written evidence and documents to refer to in support of the arguments you make and ensure all communications are made in writing and kept, as they could become crucial to a dispute with creditors further down the line.
What to do if a director’s personal guarantee is called in?
If you have signed a director’s personal guarantee that’s called in either when a business becomes insolvent or on the liquidation of the company, the first thing you should do is seek professional advice. We have seen cases where the personal guarantee has either not been drawn up correctly or has been executed wrongly, which has made it invalid.
The next step is to talk to the creditor. Legal action can be a time-consuming and expensive process and most creditors would prefer to avoid it if they can. A negotiated settlement, as long as it’s one you can afford, is likely to be preferable for both parties.
Are you concerned about a director’s personal guarantee you have signed? If your company is struggling financially and you’re worried about the impact a personal guarantee could have on you and your family, please get in touch with the team at AABRS today. We’ll provide a free, confidential and no-obligation consultation to help you understand your options.