Business owners can be put under substantial pressure to give personal guarantees to get their new business up and running or to secure crucial funding for an already established business.
In many cases, lenders, landlords and suppliers will only agree to do business if the company’s obligations are supported by a personal guarantee from one or more of the individuals who own it. But, however tempting it may be to be optimistic about the business’s future prospects, thousands of businesses go under each year. Therefore, business owners should never assume that defaulting on a loan or insolvency are beyond the realm of possibility.
Read on to learn more about personal guarantee agreements, including the consequences should you default on one.
Personal Guarantee by Directors
Put simply, a personal guarantee places the director’s personal assets at risk should the borrower default. In this scenario, some or all his or her personal assets, including the family home can be sold or liquidated to repay the loan. Therefore, personal guarantees shouldn’t be given lightly or without a full understanding of the implications should the business go belly up.
Why do Banks Require Them?
There are a number of scenarios where a lender may ask a director to guarantee a loan or financial arrangement in case the amounts being borrowed can’t be settled by the business.
They require this simply to give themselves additional security when lending out money.
These are some of the most common cases:
- business loans
- invoice finance agreements
- asset leasing arrangements
- trade supply
- property leases
What Does it Mean for the Personal Guarantee to be Unlimited?
A unlimited personal guarantee means the guarantor is responsible for 100% of the debt in case of payment default.
This is opposed to a limited guarantee which may be capped at say 40%.
The Effect of a Personal Guarantee During Insolvency
By giving a personal guarantee, the director promises that the company will stand by its obligations to repay a loan or pay rent and that he or she will do so if the company is unable to do so. Securing additional finance and giving the business a new lease of life are some of the pros of a personal guarantee. However, let’s also consider the cons:
- If a claim is made under the guarantee, the director will be liable to pay the company’s debt and if he or she doesn’t, the lender can take him or her to court to enforce a judgement debt against his or her personal assets.
- If there aren’t sufficient personal assets to cover the debt, this can damage the director’s credit rating and he or she may be made bankrupt.
- As a result of being made bankrupt, the individual can’t be company director again while the bankruptcy remains “undischarged” or the individual hasn’t been released from personal liability for the debts. Additionally, he or she is legally prohibited from managing, forming or promoting a company without the permission of the court.
- If several directors give a personal guarantee or a single guarantee jointly to the same lender, in the case of insolvency, the lender doesn’t have to take action against all the directors but can claim the whole amount from just one guarantor.
Key Considerations about Personal Guarantees for Directors
Directors considering providing a personal guarantee to one or more creditors for their business should consider capping their liabilities, or taking out personal guarantee insurance. Frequently, directors fail to reach an agreement with creditors on this issue, but it makes good business sense to limit the financial responsibilities where possible and to establish contractual clarity on the subject. By doing so, the potential for disagreements and legal disputes can be limited later on. Even issues that may initially seem insignificant can be worth clarifying because they can become vitally important if the company enters into insolvency.
How do you get rid of a personal guarantee?
Getting rid of a personal guarantee agreement once it’s signed is extremely difficult. Here are some scenarious in which you could:
Renegotiate the original contact – This is something which can only be attempted before the company reaches insolvency. With good legal assistance it may be possible to renegotitate the terms of your agreement with the lender, perhaps limiting the goods which can be seized in the event of default, or personally guaranteeting a percentage of the total loan amount.
Personal Guarantee Insurance – There is only one company in the UK (to our knowledge which offer this. If negotiated at the point of signing the contract it can offer a huge amount of peace of mind should the limited company run ito trouble. You can apply for it here.
Enter into an Individual Voluntary Arrangement – IVA’s offer the chance to pay the debt back over a period of time, usually a period of 3-5 years. There are usually negotiated for a percentage of total debts, too, meaning you won’t pay back the full amount.
Bankruptcy – Bankruptcy would discharge the amount owed via personal guarantee, as well as most of your other debts. Of course, whatever security the lender holds will be called in and if this is a family house you are likely to lose it.
How Enforceable is a Personal Guarantee?
While every contract will be different, the standard personal guarantee is extremely watertight, assuming it’s been correctly signed by the guarantor.
These documents are scrupulously put together by the lenders legal teams to make them as enforceable as possible and, as such, it would be a rare legal situation that could see someone getting out of one. Gordon Ramsay, for example, tried on the basis that his father in law had signed on his behalf via an electronic signature. The High Court nevertheless ruled it legally binding.