Corporate & Commercial legal expert Chris Brightling explains key considerations when giving a personal guarantee to secure funding.
When borrowing money for their business, company directors will often be asked to give a personal guarantee to the lender as security. In other words, the director makes him or herself personally liable for the debt if the company defaults on its repayments.
When the lender draws up a guarantee agreement, it is natural to assume that they will do so heavily in the protection of their own interests - and so it is very important that the director should consider the risks and seek legal advice to make sure they don't put themselves in a tricky situation.
In this article, we will look at what personal guarantees usually contain, and outline some of the risks and considerations.
What is a personal guarantee?
A personal guarantee is essentially a promise from the borrower to the lender that if the business is unable to repay the money, the director will be personally liable for the debt.
This provides a layer of safety for the lender so that they can have greater assurance of recouping their money, and for a company director with a high level of confidence in the success of the business, it might be easy to assume that their own personal risk would be nominal. Good unsecured business loans are not easy to acquire, and for many businesses, agreeing to a personal guarantee is a way to unlock access to otherwise unattainable funding.
However, nothing in business is ever certain, and a sensible company director may wish to take some precautions to make sure they don't land themselves in hot water later on.
Personal guarantees are binding contracts, and from the moment the guarantee is in writing it becomes legally enforceable. There is no set time period during which a guarantee can be valid - it depends on the specifics set out in the particular guarantee.
What are some considerations when signing a personal guarantee?
When borrowing money, a director might wish to consider the following:
- If it becomes necessary for the director to cover the debt using their own assets, and they are not able to, they may personally face bankruptcy and disqualification from any future activities as a company director. Even if things don't get that serious, the director may at least experience a negative effect to their credit rating if they should fall behind on their repayments.
- Personal guarantees can often be subject to immediate repayment if demanded by the creditor - and this will likely be at their sole discretion.
- Sometimes, personal guarantees may include an 'indemnity' - in other words, an agreement that the debtor will pay for any losses suffered by the creditor. Of course, from a company director's point of view, providing an indemnity is best avoided wherever possible.
- Personal assets used to secure the guarantee can be sold by the bank without needing to go to court. This might include the director's home.
- Careful attention should be given to provisions in the guarantee that may also put the director personally on the hook for future debts and accrued interest.
However, it's important to note that if the company itself is in a position to provide security on the loan, there may not be any need for a director to assume personal liability for the debt.
Some questions that a director might like to consider before signing a personal guarantee could include:
- What exactly is considered a default under the terms of the guarantee?
- How would the creditors enforce the guarantee?
- Would they serve notice for monies owed, or simply demand payment?
- Is there a remedy period?
- Are the circumstances of the director's personal finances or assets likely to change after the event of signing the guarantee?
- Is there any provision in the guarantee requiring that the creditor should make personal demands on the director only as a last resort?
Directors' personal guarantees can often be written in such a way that they include a cap on the director's personal liability. However, it is (unsurprisingly) difficult to negotiate these into the agreement if the business is already in trouble - so it is definitely worth seeking to make this part of the contract ahead of time.
In all cases, a company director considering signing a personal guarantee to secure a business loan should seek expert legal advice to ensure that they aren't inadvertently putting themselves at risk.
Offering a personal guarantee is often necessary to secure the funds needed to grow a business, but it always pays to take sensible precautions.
By considering the risks carefully and working with a solicitor to understand the terms of the contract, nasty surprises can be avoided and all parties involved can move forwards with confidence.
For further advice on this and any other Corporate, Banking & Finance issue, please contact a member of our Corporate, Banking & Finance team.