Personal guarantees

What is a personal guarantee?

When you provide a personal guarantee to a third party creditor, usually the bank or another business lender, you're agreeing to act as guarantor for the debt obligations of another party, the principal — for example your company. That means if your company defaults on a loan repayment, you've guaranteed that you'll step up and pay instead.

How long does a personal guarantee last?

In the context of business finance, the terms ‘personal guarantees’ and ‘director’s guarantees’ are used interchangeably. A director’s personal guarantee is a means of security used by the lender as protection when lending to your business. 

As a company director, you might consider offering a personal guarantee as an assurance for a business loan or another source of credit. This is called ‘piercing the corporate veil’ and the lender could pursue you personally if your company goes insolvent. 

But is it a risk worth taking?

It can certainly be an attractive option. In times of financial security when business is good, personal guarantees by directors can be a means of attaining the business finance required to improve cash flow or expand that might otherwise be denied. 

But before you become a business loan guarantor, you should know the legal basics of the contractual relationship you're entering, and the prospects and consequences on your personal assets if the personal guarantee is enforced.

Two basic features of the personal guarantee to bear in mind:

First, the personal guarantee should not be an indemnity – which is in itself a primary obligation to pay further damages to reflect a lender’s loss – and it's not contingent on the obligations of the borrower. When examining the detail of a contract that claims to be a guarantee, it's important to recognise if you will be acting as an indemnifier, a guarantor, or a mixture of the two.

Second, your personal guarantee may or may not be supported by security, which could be a charge over your own home, and would potentially make it easier for a creditor to seek enforcement in the event of borrower default.

Key Considerations

A personal guarantee will not be enforceable in any terms unless it's in writing and signed by the guarantor. Beware of the predicament that celebrity chef Gordon Ramsey fell foul of, however, when his signature — as produced by a signature machine operated by his father-in-law — was deemed by the High Court to be effectively binding, on the basis that the father-in-law acted as an agent throughout a long-standing business relationship. Personal guarantees that are expressed as a deed and formally delivered and with wording as to that in the intention are likely to be treated as unconditional.

It's unlikely that any negotiations with a creditor seeking to enforce the guarantee will be straightforward, particularly if your company’s financial situation is drifting towards insolvency – so consider any such talks early on because your scope for reducing your liability will be broader the better the prospects of recovery are.

One way to provide some certainty to the potential outcome should the guarantee come into play is to consider capping your liabilities at the drafting stage. It might not be possible with all lenders, but if it can be agreed it will mitigate your loss and provide reassurance.

Ensure you're comfortable with all the terms of the guarantee

• How does your contract suggest creditors will enforce the guarantee?

• Will they serve notice or can they seek payment on demand?

• What exactly will constitute a default?

• Do terms allow for any remedy period?

• How were your net assets assessed prior to the giving of the guarantee, and is this likely to change?

• Does your contract provide that creditors exhaust every other avenue before making demands on you?

Worth Taking the Chance?

Personal guarantees are certainly an attractive funding option and provided you are clear on the terms in which you are providing the guarantee, you can have contractual clarity on all eventualities. Be as objective as you can about the financial prospects of your business and its commercial value, and always remember that your guarantee is not a hypothetical assurance. Creditors can and will enforce them, and challenging their right to — or convincing a court that a term is unfair — will never be a straightforward process.

Pros and cons of giving a personal guarantee

Here’s a look at some of the key potential advantages and disadvantages of personal guarantees from a director’s point of view:

Pros

Cons

Other issues to consider

For company directors who are convinced that the pros outweigh the cons when it comes to personal guarantees, the details of the terms should become the primary area of focus. The aim should be to establish with as much clarity as possible what commitments are being made and what the potential ramifications could be.

Personal guarantee insurance

Personal guarantee insurance provides insurance cover for those who have signed a personal guarantee. It is designed to protect the guarantor should the personal guarantee be called by the lender. The cost of insurance will depend on how big the guarantee is and what assets are being secured against the loan. Bear in mind that the insurance will never cover the entire amount of the guarantee.

If you’d prefer not to offer a personal guarantee at all, we’ll search the market to find the finance solution that suits you best — there may be a lender out there that doesn’t require a personal guarantee for your circumstances.

We specialise in helping business owners access and understand the range of finance available to them. Although we can’t give advice on personal guarantee insurance (and don’t provide the service ourselves), we can refer you to personal guarantee insurance experts who can.

What happens if you default on a personal guarantee?

If you default on a personal guarantee you will lose the asset that you used as collateral. The lender will send a letter containing their payment terms which you should check against the loan agreement you signed. You’ll have to pay within a specific timeframe or the lender will start legal proceedings against you or petition for your bankruptcy. 

How long is a personal guarantee valid?

Typically, the ‘limitation period’, which is the maximum amount of time to commence legal proceedings, is six years from the date that the breach of contract occurred (usually 12 years for deeds).  

What is an unenforceable personal guarantee?

A personal guarantee might be unenforceable if the ‘limitation period’ has passed. However, there are a few other reasons that might deem a personal guarantee unenforceable. For instance, if fraud has taken place, if you, as the borrower, were misled by the creditor, or if the facility you took out changed significantly from when you signed the guarantee to when the claim was made, and you weren’t aware of the changes. 

This article was written with valuable input from Hannah Newell, Corporate and Commercial LawBrief at Lawbite, and John Baird, insolvency expert at Scotland Debt Solutions.