Personal guarantee: how to negotiate
- Helen Curtis
- Updated: Thu, 24th Nov 2016
A personal guarantee means you pledge personal assets which the lender can seize and sell if your company does not repay a debt. The risk is not just loss of personal assets but also disqualification as a director and personal bankruptcy. When we negotiate, we precisely define and limit the provisions, cap your liabilities, and significantly reduce your risk.
Our services to personal guarantors include:
To improve the chances of enforceability the lender will ask guarantors to take independent legal advice before entering into a personal guarantee – this is a service we provide for guarantors. We support private companies and partnerships and by minimising your obligations and risks.
Defining personal guarantee provisions
A company has a separate legal status, and is responsible for its debts. Thus, lenders cannot easily recover the company’s debts from directors or shareholders. Similar rules apply to limited liability partnerships.
So lenders often demand personal guarantees which can be relied on by the lender, if the company defaults on its debt repayments. This guarantee is not an agreement between the company and the lender, but between an individual and the lender. Thus the lender gains additional security. The individual guaranteeing the loan must ensure that the guarantee agreement is fit for purpose.
We find guarantee documents contain onerous provisions, which we first clarify. Thus we reduce the chance of disputes emerging. Issues that might seem unimportant and unlikely to be of any real consequence at they time of entering into the personal guarantee can become important if the guarantee is called upon by the lender.
The lender is not obliged to advise you on the provisions or their effect. Remember, not only can the lender liquidate your business, but also personally bankrupt you.
Provisions that catch out guarantors include:
- Obligation to pay the banks costs if the loan is repaid early;
- Repayment on immediate demand;
- No power to negotiate repayment terms.
Common situations where lenders demand personal guarantees include:
- Business loans;
- Property leases;
- Trade supply deals;
- Asset leasing arrangements;
- Invoice finance arrangements; and
- Management buy-outs.
Managing the consequences of a personal guarantee
If you sign a personal guarantee, you promise the business will fulfil the obligation, e.g. repay a loan, pay rent. If the business does not fulfill the obligation, you fulfill them. If you, the guarantor, do not settle the debt, there are consequences:
The lender, the guarantee’s beneficiary, takes the defaulting guarantor to court. The result is often a judgement debt against the director’s personal assets, including the family home.
Joint and several liability
If several directors “jointly and severally” give the same bank a personal guarantee then the bank:
- Does not have to take action against, i.e. chase, all directors; but
- Can claim the whole amount from any single guarantor.
Advising on secured guarantees, third party charges & indemnities
Often the bank takes security over the guarantor’s assets. Then the bank can sell the guarantor’s assets to meet the guarantors’ debts, without going to court.
These assets usually include your family home. However, if the guarantor co-owns their home with their spouse, then banks usually require co-owners to also provide the security.
Usually, banks insist the guarantor and co-owner take independent legal advice before giving the secured guarantee. This reduces a co-owner’s ability to challenge the guarantee’s enforceability, by arguing undue influence or misrepresentation.
Personal guarantee combined with security over assets
A personal guarantee combined with security over assets in a single document is called a ‘third party charge’. Under this agreement the director’s liability is usually unlimited.
We often negotatiate “non-recourse” charges. When settling the company’s debt, its advantages are:
- Liability is limited to the charged property’s value;
- If the property sale does not generate sufficient funds, then
- There is no further recourse to the director or his remaining assets.
Often lenders add indemnities to personal guarantees. We spot and resist these indemnities. They are dangerous:
A guarantee depends on the business repaying the debt. The amount guaranteed should not exceed the amount the business owes the lender.
However, an indemnity is independent of the business and lender’s relationship. It is a primary obligation. It can even apply after you’ve paid off the debt. The way an indemnity works is:
- If the business fails to meet its obligations, and
- Consequently the lender suffers losses; then
- The indemnity assures the lender; that
- The person giving the indemnity pays those losses.
For instance, an indemnity might require you to pay the banks’s legal and court costs to pursue the debt repayment.
Advising on potential areas for negotiation
When banks insist on personal guarantees, we usually negotiate the following:
Scope of the guarantee
We aim to link the guarantee to a specific loan. We avoid “all monies” guarantees, since that covers all the business’s borrowings.
Capping the amount payable
We prefer to cap the amount paid under the guarantee. This limits your liability and provides certainty.
Ideally the guarantor should be able to terminate the guarantee, e.g. when she ceases to be a company director or shareholder. However, the bank may only agree if:
- Alternative security is provided; or
- The outstanding loan amount is repaid;
Before you sign the guarantee, we find ways to protect your position within the business.
The bank should only enforce the guarantee on the condition it first enforced its security over the business’ assets. This should be in writing.
Recently, some directors claimed the personal guarantees they gave a bank were conditional. The condition was that the bank would first enforce its debenture over the business’ assets, before claiming against the director’s guarantees. At the Court of Appeal, the director’s failed, because this wasn’t written down.
Explaining directors’ duties
Any director who gives a guarantee must declare their interest, in the relevant transaction, to the other directors. The articles of association may prevent this director voting on the matter. In some articles, guarantees are an exception. We often review and co-ordinate the articles with the shareholder or LLP agreement.
Conflict of duty
The guarantee may create conflict between a director’s personal interests and the company’s interests. A shareholder’s resolution, or if the article’s permit the other directors, should approve this situation.
A director giving a guarantee is accepting additional obligations and risks. We often amend director service agreements to cater for these obligations and risks.
If a company gets into financial difficulties, preferential treatment is where a guarantor who is also a director pays a creditor, to whom he gave personal guarantees, before other creditors. Preferential treatment is a breach of duty.
Directors owe a duty to the company. However when insolvency threatens, they owe a duty to the company’s creditors. A court could:
- Unwind the transaction;
- Disqualify the director, because of the breach of duty;
- Leave the director, personally, with the liability he guaranteed.
Pay debts as they fall due
Company directors should pay debts as they fall due. They should not prefer one creditor, including a lender, over another.
A liquidator can apply to the court to set aside any transaction within the six months preceding the liquidation. The liquidator must prove the director was influenced by a desire to protect himself, and thus preferred that particular creditor or lender.
Connection between guarantor and lender
The six month period is extended to two years, if the lender is a “connected person”, e.g.
- Company shareholder;
- Director; or
The courts presume a desire to prefer the lender, unless you prove the opposite.
Limiting your risk
We ensure guarantors can access the company’s business accounts and other records. It is a criminal offence for a director to refuse access to the accounts. The director could be disqualified.
However, under the Companies Act, only directors have the right to inspect accounts. Note, the act does not clearly define timescales and mechanics.
To further reduce the guarantor’s risk, we ensure:
Access to business records
We enhance the limit provisions within the Companies Act. We give guarantors the right to access whatever business records they consider necessary.
Right to repay loan
Given sufficient funds, the guarantor gains the right to direct the company to repay the loan.
We draw up a list of issues to which the business cannot agree without the guarantor’s consent. In effect the guarantor gains a right of veto.
Guarantor approves winding up
The Companies Act requires 75% of shareholders to vote for a voluntary winding up. We change this provision to require the guarantor’s approval as well.