What is a Personal Guarantee?
A personal guarantee is an agreement between an individual (usually a business owner) and a lender, whereby the individual agrees to act as a guarantor, and will therefore be, personally responsible for paying back a loan granted by the lender to a borrower (typically the business owner’s company), in the event the borrower fails to make the repayments.
Personal guarantees impose significant and serious obligations on guarantors and should never be entered into lightly. Where a personal guarantee is required by a lender, the guarantor will be required to seek independent legal advice and should always carefully consider the advice given, before entering in to the contractual arrangement. There are also a number of practical points a guarantor should consider when required to enter into a personal guarantee, in order to better manage the inherent risks.
Is the Personal Guarantee actually required?
Lenders will sometimes request a personal guarantee when the guarantor has previously entered into one with that lender, or the borrower itself already has adequate security it can offer. If the borrower is of good financial standing and has sufficient assets, it’s always worth challenging the lender as to why they are requesting further security in the form of a personal guarantee. Sometimes this comes down to it being part of the lender’s standard administrative process and a general unfamiliarity on the lender’s part, as to what previous arrangements have been entered into .
Where a personal guarantee is already in place, due to the fact personal guarantees are almost always expressed as “all monies” (meaning they are intended to cover any liability owed to the lender now or in the future), if further borrowing is incurred from the same lender in the future, this should already be covered by the existing guarantee (subject to any financial limits on any existing guarantees). Notwithstanding this, where a lender insists that a guarantor must enter into a further personal guarantee, the existing guarantee should come to an end rather than two separate guarantees being in place. This is an important point to address with the lender at the outset, if the guarantor wishes to avoid potentially being on multiple hooks for the same or similar levels of debt.
Do other individuals within the business have the ability to incur further financial expenditure on its behalf?
Where an individual is required to enter into a personal guarantee on behalf of a business, they should carefully consider how the business’ ability to incur further financial expenditure or borrowings is controlled. This can be achieved by closely monitoring business expenditure and setting financial caps on expenditure with other business owners. Putting in place contractual agreements such as a Shareholders’ Agreement can also ensure that those in a position to incur further borrowing on behalf of the borrower, are not given a blank cheque to do so, at the ultimate expense of the guarantor.
Although a sole director/shareholder may not consider this necessary at the point they are entering into a personal guarantee, they too should be mindful of this potential risk if further directors/shareholders come on board at a later date.
Will the Personal Guarantee automatically come to an end upon the debt being repaid in full by the borrower?
Your legal adviser should always check the particular wording of the personal guarantee, as they are typically expressed to remain in place, even after the debt has been repaid to the lender. This is to ensure any future further indebtedness of the borrower is covered which, although ideal for the lender, is not ideal for a guarantor who may have assumed their obligations and potential liabilities under the personal guarantee when it came to an end and when the borrowed sum was repaid in full.
There are also two further incorrect assumptions guarantors can often make: -
- That the personal guarantee will cease to apply in the event of their death. This is usually not the case as if called upon, the sum covered by the personal guarantee will become a debt on the guarantor’s estate.
- If they leave or sell the business they gave a personal guarantee on behalf of, it will no longer apply. As mentioned above, generally speaking, personal guarantees do not automatically come to an end and so if overlooked, there is a risk the guarantor could find themselves personally liable for the debts of a business they are no longer connected to.
As a result, a guarantor should always be aware of the status of the personal guarantee and seek a release from the lender as soon as possible, in relation to any personal guarantees they’ve previously entered into. This will minimise the risk of an unpleasant surprise further down the line.
Keep a register of Personal Guarantees
Owners of new businesses with little or no trading history and assets are often required to enter into multiple personal guarantees. It’s not uncommon for business owners to take the view that this is a necessary evil they must go along with, if they are to secure the investment they require in order to grow the business. However, considering the onerous obligations and potentially serious repercussions of a personal guarantee being enforced against the guarantor, it’s sensible to keep a register of any guarantees entered into. Doing so, will not only enable a guarantor to keep track of where commitments have been given but also of who needs to be approached to seek a release of the personal guarantees at the earliest opportunity.
Seeking advice from an Independent Financial Adviser
Where a guarantor has multiple sources of wealth, it is also worth seeking advice from an Independent Financial Adviser as to how that wealth can be managed, in the event a personal guarantee is enforced by the lender. Doing so is not only reassuring but may prove invaluable in minimising the impact a personal guarantee can otherwise have on an individual’s personal assets.
Anyone who has signed a personal guarantee can attest they are relatively easy to enter into and not so easy to get out of. Even if a personal guarantee appears to no longer apply, unless the lender has expressly confirmed this, the obligations entered into are likely to remain enforceable against an individual and their personal assets.
In addition to receiving the required independent legal and financial advice before entering into a personal guarantee, considering these practical points may help prepare you to manage the inherent and less apparent risks involved in proceeding with entering into such an arrangement.