Inevitably the answer will be “It all depends…”
What is a personal guarantee?
When looking for business finance, a company director might well be asked to give a personal guarantee as a condition of a business loan or another source of credit being granted. This puts the director into a direct relationship with the funder who could pursue the director personally if the company becomes insolvent or is unable to service the debt on the agreed terms. This means for instance that if a director’s company defaults on a loan repayment, the director will pay it personally instead.
A personal guarantee is no afterthought
A personal guarantee is sometimes mentioned in passing or as an afterthought by a lender when arranging finance. For anyone considering a personal guarantee, the last thing it should be is an afterthought. This article should help directors be forewarned about some of the issues.
Guarantee or indemnity?
At the outset it is worth noting that a personal guarantee is different from an indemnity.
An indemnity gives protection against loss, in terms of money to be paid for a loss that crystallises. An indemnity is when one party promises to compensate the loss incurred by the other party which occurs for specific reasons stated in the indemnity. An indemnity for instance could cover damage caused to a hire car. There are two parties in an indemnity.
A guarantee is when a person assures the other party that they will fulfil the obligation of a third party, in case they default. There are three parties with a guarantee.
Generally an indemnity is more advantageous to the beneficiary whilst a guarantee is usually more advantageous to the guarantor. Personal guarantees must be in writing which indemnities do not have to be. Something to watch out for though is indemnity wording including in the guarantee. This means that if, for any reason, the underlying agreement between the lender and borrower fails, the lender can still rely on its indemnity. This article considers personal guarantees
One size does not fit all
Personal guarantees come in various shapes and sizes according to the terms in them. Some guarantees are more onerous and risky than others and it is often worth running the actual guarantee wording past a professional accountant or solicitor before signing the document.
What are the precise terms of the guarantee?
- How does the contract (which is supported by the guarantee) stipulate that the creditor will enforce the personal guarantee?
- Will the creditor serve notice or can they seek payment on demand?
- What exactly will constitute a default?
- Do the terms allow for any remedy period?
- How are your net assets assessed at the time of giving the personal guarantee? Are your assets likely to change? Remember that all personal assets (including the family home even if co-owned by someone else) are at risk with a personal guarantee.
- Does the underlying contract provide that the creditor exhausts every other avenue before making demands on you?
- Is the personal guarantee unlimited in value or is it capped at a figure?
- Can the guarantor be pursued for costs and interests? Usually under the guarantee they can be pursued and any costs and interest will be over and above any capped amount.
- Is the personal guarantee supported by security (eg a charge over your own home?) A charge would make it potentially easier for a creditor to seek enforcement in the event of borrower default.
- Is the guarantee time limited? How is the guarantor released from the guarantee?
- Does the guarantee require the spouse/civil partner of the first guarantor also to give a personal guarantee?
- If there is more than one guarantor, is each guarantor liable for the full amount? Often, the guarantors will be ‘jointly and severally liable’. This means that the funder can pursue any or all of the guarantors for the full amount. For example, if there are two guarantors, they will both be liable for the full amount due under the guarantee (not half each). The funder can then choose which guarantor to pursue, if not both. The guarantors then argue amongst themselves about any money that is owed between them (Note 1).
- What warranties and representations are made by the guarantor? These need checking to ensure that they are true otherwise the funder could sue under breach of contract.
Other things to consider
- If a business is obtaining funding, be careful about signing a personal guarantee if you are not part of the executive management team and do not really have a full view of the company’s plans or finances. If you are guaranteeing finance for a company you should have the right to influence the decisions of the company.
- If you do sign a personal guarantee, make a careful note of it (put a copy of it in your personal papers) and remember to ensure you are released from its obligation when the funds are repaid. It is not unknown for an old guarantee to come out of the woodwork many years after it was given and long after the original funding was paid back. In one case a director had to cover personally a huge amount of trade finance relating to new large contract that was granted many years after the first modest funding had been repaid but the director had forgotten that the existing personal guarantee had never been revoked.
- Look carefully at alternative possible sources of funding and consult a professional adviser. The British Business Bank is a good starting point.
A personal guarantee should always be entered into with care and caution and it is often wise to obtain professional advice.
Note 1 – Joint and several liability
A real example (names changed) of this was in a UK funding proposition for £300k from a reputable funder for a new business venture in the advertising sector with three partners in London. Alfred was young, single and from the USA, he rented a room and had very few assets. Brian was British, single, rented his home and had few other assets. Colin was British, married, a home owner with a mortgage and significant equity in the house. His wife was pregnant with their first child. Should Alfred, Brian and Colin each sign a joint and several guarantee? Alfred and Bryan signed but Colin who didn’t ‘do finance’ thought he should run the idea past his professional adviser (a lawyer in his case). The adviser explained in words of one syllable the lop-sided risk Colin was taking compared to his friends. The funding was stopped in its tracks and the venture never happened. Lesson learnt however, Colin went on to be highly successful in his own business and his baby became an equally successful and highly respected business adviser.