A personal guarantee may be required of directors by any entity or person who is lending money to a company. The loan itself, and responsibility for the monthly repayments of the loan remains with the company. However, if the company defaults on the loan and either fails to meet the monthly repayments or fails to pay the loan when called in, the lender can pursue not only the company, but can also the directors personally up to the value of the personal guarantee that a director has given. In this article, Insolvency Solicitor Eleanor Stephens looks at the options available to directors that have provided a personal guarantee for a company that is insolvent.
When is a directors personal guarantee usually required?
A personal guarantee is frequently a requirement of a bank when lending to a company, especially when providing an overdraft facility. It may also be required of a landlord when entering into the lease of a company premises. Some particularly strong trade creditors might insist on it before dealing with a company, although this is more rare. Invoice discounters may also request a personal guarantee, along with the usual security by way of fixed and floating charges.
What is the risk to directors on a company insolvency if they have provided a personal guarantee?
As directors often have little choice but to give a personal guarantee for some essential borrowing, they inevitably end up doing so. When signing a guarantee no-one likes to think that the worst will happen and it will be called in, but if it does, it can have drastic personal consequences for the directors, particularly when the company enters an insolvency situation.
Generally, when a company goes into formal insolvency the return to a company’s creditors are limited to the company assets available, and the directors are protected by the ‘corporate veil’ which means their liability personally is only up to the value of their shareholding.
However, if there are insufficient assets available to meet company debt, which is almost inevitable on a company insolvency, then a lender who has the benefit of a personal guarantee from the directors will usually take a two pronged approach to recovering their loans. They will seek this both from the company itself, and also personally from the directors.
Joint and several guarantees
If one or more directors have given a personal guarantee, the terms of that guarantee will usually state that the debt is owed jointly and severally. The lender can therefore pursue the full amount of the shortfall from any one or all of the directors personally. They cannot however be repaid twice, so can only ever receive the full amount of the loan outstanding, either from the company itself, or the director/s, or a mixture of a contribution from all.
If directors do not have sufficient capital personally to meet a personal guarantee then they risk a bankruptcy claim by the lender to recover the money. If that happens, all of the director’s assets can be used to repay the guarantee, including the director’s home.
What options are open to a director when given a personal guarantee?
Often a director has very little or no negotiating power when it comes to obtaining a facility from a lender or other entity which is vital to growing and maintaining their business. They either must provide a personal guarantee, or forgo the lending or deal.
However, while the giving of a guarantee may seem non-negotiable in many circumstances, there are some actions a director can take before giving a guarantee to try to mitigate the damage should this be called in.
Firstly, take legal advice from an Insolvency Solicitor to ensure you are fully aware of what a personal guarantee will mean for you. Many banks will insist on this in any event, so that directors are fully aware of the implications of giving a guarantee.
It may be possible to negotiate to limit the extent of the guarantee. This will at least set a financial limit on what may be claimed from you in the event of default. It may be possible for a guarantee to be limited in time too.
In any event, is essential that the terms of the guarantee are very clear and both sides know when and how the guarantee might be called in. This should be discussed with your legal adviser before you sign anything.
Explore with the lender the options for taking security over company assets as an alternative to a personal guarantee. Often lenders will require both, but it very much depends on the circumstances, and the lender.
Look at alternatives for funding before giving a personal guarantee. There may be investment options rather than lending options in order to create more working capital, and these are less likely to require personal guarantees. Again, take legal advice before entering into any agreement, as there will inevitably be other considerations when taking on new investment, which will need to be weighed up.
There are insurance policies that will cover personal guarantees. Explore the options and costs of these before giving any guarantee.
If you are giving a personal guarantee with other directors, look at the whole situation, and in particular what are the personal finances of your co-directors, to look at your own risk. If your co-directors are not property owners for example, the risk to you when the guarantee is called in is going to be higher for you than for them. Maybe this can be reflected in the level of guarantee given by each director.
Maintain accurate financial records, which will help you to predict cash flow fluctuations, and will give you more time to look for alternative funding methods before the company reaches crisis point and a personal guarantee is the only option.
How can we help?
Personal guarantees are often given by directors in a rushed situation where they urgently need more cash and have very little time to look at the alternative options. As a result, they are forced into a guarantee that may be disastrous for them personally.
At Harper James our Corporate Solicitors will consider the terms of any proposed funding agreement with you, including a personal guarantee, and advise you on the possibilities of strengthening your personal position before signing up to a personal guarantee.
If the worst-case scenario happens, our Recovery and Insolvency solicitors can provide you with specialist advice on what your obligations are under a guarantee that is called in, and work with you to reach the best solution for you in the circumstances.