Personal guarantees pledge personal assets which the lender can seize if the borrower defaults.
Banks have commonly required business owners of small and medium sized businesses to provide personal guarantees. This is nothing new. What is new is the urgency in the current coronavirus/covid-19 pandemic for businesses to obtain emergency loans.
Obtaining bank finance in the current situation is the difference between survival or not for many thousands of businesses. Helpfully, the largest 4 UK banks have agreed not to require personal guarantees for loans of under £250,000.00. If your business needs to borrow due to business interruption from other lenders or you need to borrow more than £250,000.00, before agreeing to any personal guarantee to support a loan during the coronavirus/covid-19 pandemic, it is vital that you understand all the implications.
Lenders require guarantors to take independent legal advice on the implications and risks under the personal guarantee – we offer this advice.
Our fees for a review and signature to confirm you have received independent legal advice are £490 plus VAT. Where there is more than one guarantor for the same loan there is a discount.
We explain in easy language how the personal guarantee operates and the implications.
Legal consequences of providing a personal guarantee
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. Means of recovery include injunctions and court litigation which can be lengthy and expensive.
So lenders often demand personal guarantees. If the company defaults on its debt repayments. the lender has additional security in the form of the personal guarantee. The guarantor risks his or her home and personal assets if the borrower defaults and fails to repay the loan.
Risks with personal guarantees
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.
Personal liability under the personal guarantee
If the business does not meet the payments or obligations required under the guarantee then you as the guarantor have a personal obligation. The risks can include:
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.
Security for the personal guarantee
Often the bank takes security over the guarantor’s assets. Then the bank can sell the guarantor’s assets to meet the 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 guarantees combined with security
A personal guarantee combined with security over assets in a single document is called a ‘third party charge’. Under this agreement the guarantor’s liability is usually unlimited.
A non-recourse charge is beneficial. This is because:
- Liability is limited to the charged property’s value; which means
- If the property sale does not generate sufficient funds there is no further recourse to the director or his remaining assets.
Indemnities under personal guarantees
Often lenders add indemnities to personal guarantees. Indemnities can have a greater impact on personal liability than a guarantee. This is because 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 can even apply after you’ve paid off the debt.
The way a personal guarantee 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.
Limiting risk under a personal guarantee
There may be an opportunity for a guarantor to limit risk under the personal guarantee. The opportunities will vary from company to company. We summarise some ideas which we have put into practice.
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 with reasonable notice. The Companies Act only extends to directors and gives no time scale. The articles or shareholders’ agreement can provide enhanced rights.
Right to repay loan
The articles or shareholders agreement can be revised to provide that given sufficient funds, the guarantor gains the right to direct the company to repay the loan. This type of clause stops others being paid before the bank loan is paid off.
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 given the financial stake at risk.
Amendment to director or employment agreement
A director giving a guarantee is accepting additional obligations and risks. We often amend director service agreements to cater for these obligations and risks. For example, you need to think through what would happen if you were dismissed. Without expressly dealing with the point the personal guarantee continues which may be far from desirable.
Disputes over personal guarantee enforceability
There can be legal issues or loopholes with personal guarantees and sometimes there are opportunities to negotiate. Whilst the best option is usually to find ways to limit the personal guarantee, we do have clients who instruct us to challenge the enforceability. If you need good legal advice on this aspect, we can help.