Directors’ personal guarantees are a measure of security used by financial institutions and lenders to protect themselves when providing loans.
When directors seek funding for their business and sign a ‘personal guarantee’, it is a legally binding waiver that bypasses the limited liability status of a limited company during debt recovery.
In such cases, the company directors’ personal assets may be at risk as they become liable for the relevant business debt that is covered by the guarantee.
What is a Directors’ Personal Guarantee?
When seeking funding for a business, many business loans, financial arrangements, or leases require the company director to sign a personal guarantee as a form of security for the lender.
Since the limited company structure is designed to keep the directors’ personal finances completely separate from those of the business via the limited liability status, these clauses are extremely significant and should not be undertaken lightly.
Signing a directors’ personal guarantee is referred to as ‘piercing the corporate veil’ and it means that, in the case of insolvency, the guarantor has the right to come after your personal assets.
For this reason, we always advise considering personal guarantee insurance which is a relatively new offering, but brings a lot of piece of mind.
What Happens if you Default on a Personal Guarantee?
In usual situations, defaulting means you are going to lose whatever asset you put up as collateral – that is, assuming the guarantee is supported by security of some kind.
If the guarantee is called in, you will receive a letter from the lender stating their payment terms. At this point, you’d be wise to check the wording in your facility agreement very carefully to ensure the terms are applicable with what you signed.
Following on from this, you will need to pay within the timeframe described. If you do not, the guarantor has two options:
- begin legal proceedings against you
- petition for your bankruptcy
Assuming you still own the asset which you used as a guarantee (often a family house), the lender will likely push for a high court judgement against you. After this, they will have the right to enforce that judgement either by seizing and auctioning goods, or a ‘charging order’.
A ‘charging order’ gives the lender rights over whatever asset you used as collateral, and it may come with an order for a forced sale.
Unlimited Personal Guarantees
Personal Guarantees are usually on either a limited (capped liability) or unlimited basis. An unlimited guarantee means that you are guaranteeing that the lender will recover 100% of their debt, including recouping any legal fees.
Is a Personal Guarantee Legally Binding?
They are enforceable – the standard practice would be for a creditor to take the debtor to court, with the intention of requesting them to enforce a judgement debt against his personal assets.
That said, there are legal precedents for the challenging of a creditor’s right to call a personal guarantee. It is recommend you seek legal advice to assess whether your case has grounds to challenge the validity of a creditor’s case.
Do They ‘Cap’ the Directors’ Liabilities?
Every personal guarantee is different so you should check the small print for your particular situation, or consult a specialist to receive advice for your business.
If your guarantee does not contain such a clause, but your company has become insolvent, it is technically possible to negotiate with creditors that personal guarantee obligations be removed, though it is difficult to do so.
For obvious reasons, creditors are rarely inclined to give up this safety net.
If you are approaching insolvency and have a guarantee in place, your chances of negotiating leniency around this would be strongly improved by prompt action.
Directors Personal Guarantee Insurance
PGI is a new and specialist insurance offering which can be paid by the limited company as a means of protecting directors who guarantee loans in case of default.
The insurance will not be against 100% of the amount but will start at about 60% and then rise to a maximum of around 80% after 5 years.
What Happens to a Directors’ Personal Guarantee in Insolvency?
Keep in mind that most personal guarantees are a form of security for the creditors and are written so that the company does not have to liquidate to be ‘called in’, but may only be in arrears, or may have had a CCJ against the company and even simply not followed terms & conditions.
Whatever the reason you must act quickly so seek specialist personal guarantee advice sooner rather than later if your company is insolvent or in financial difficulty.
The most common problems with directors’ personal guarantees arise over time, however, usually become real when a company is liquidated and the main debtor (your company) is not in a position to pay.
It is worth understanding a personal guarantee is not a secured liability, it is unsecured. The debt still remains unsecured unless it is secured by other means such as; a debenture on the company assets via fixed or floating charge, or a fixed second, charge on personal assets such as the family home.
These personal guarantees can take quite a few shapes and will often depend on the business that you are involved in.
It is possible via some insurers to set up personal guarantee insurance before your business becomes insolvent, which can help to minimise the risk against you personally, should the worst happen.
Any loan signed by a director is likely to have a clause which allows the lender to recall that money, at any time. Known as the ‘Insolvency Clause’, this is essentially a protective policy of additional security for the lender, making sure that even in cases of insolvency, the debt will still be recoverable. This is the key to the ‘personal’ liability incurred by directors who have signed these documents.
Although administration is intended to provide some form of security by putting a protective ring-fence around a company’s financial affairs, this does not extend to personal guarantees. In cases of insolvency (including administration), the usual scenario is that the guarantee provider will immediately issue a demand for the full balance. Directors should expect to receive a fairly aggressive statutory demand letter not long after the insolvency is announced requesting full payment (plus interest and charges).
The use of the word ‘personal’ in ‘personal guarantee’ is the clue that this type of guarantee falls outside the usually limited liability offered directors of a limited company.
An interesting situation arises when, if the creditor (ie the bank) then receives their money as a part of the administration, the director that has had his guarantee already called on would become what is called a ‘subrogated creditor.’ He has the right to contact the IP and inform them that any dividends payable on the estate will now be due to himself. Presumably, the bank will need to confirm this.
The Director Cannot pay the Guarantee
When a director cannot pay back the guarantee, then the loan security will be called in. In a company administration, for example, where a director has put up his house as a guarantee, this might mean he is forced to sell the house in order to satisfy a creditor.
Directors’ Personal Guarantees in Liquidation
A directors personal guarantee for a business debt remains unsecured and does not become a secured debt because the company is entering liquidation. The only exception to this would be if the personal guarantee is supported with a charge on the company assets (a debenture), this would make the debt secured.
It doesn’t matter who the personal guarantee is with, in the vast majority of cases a liquidator (appointed insolvency practitioner) will not be able to advise you on what action to take. The reason is simple while they may have a duty of care towards the directors when considering personal guarantees they are acting for the creditors (the people your business owes money to). So they are likely to be acting for the very companies you have personal guarantees with, so are not allowed to advise you personally by law.
In the liquidation engagement papers that you asked to sign before entering the liquidation process, you are advised to seek your help with regards to personal matters (personal guarantees) falling out of the liquidation. The advice required is not easily found as it is very unlikely that your accountant can provide such specialist information and, or help. You will need specialist insolvency and commercial help when dealing with personal guarantees and while there are legal similarities each bank responds differently; inevitably, this kind of advice can be very expensive due to the time and expertise required.
Are They Affected by Winding Up Petitions?
Once a winding up petition has been issued by an angry creditor, a director or guarantor who is personally liable for some of the ltd company’s debts must be careful how they respond. They cannot offer to pay the debt from company funds, assuming the bank account has not been frozen. The reason is simple this would be regarded as a preferential payment.
Banks typically have the right to call in the personal guarantee at any time. If the company runs into difficulty, the bank will usually convert the unpaid company debts into a personal loan often interest-free. This allows the loan to be paid off from any personal assets and income that the director earns after the insolvency of the company, rather than having to find a lump sum immediately. The lender may decide to review the situation at a later date to increase payments so that the debt can be paid off in a reasonable amount of time.
The best course of action in this situation is for guarantors to act before the liquidation and seek advice promptly because once the company goes into formal insolvency, the bank will pass the file to the collection department and this window of opportunity is closed.
Personal Guarantee on a Commercial Lease
In principle, there is little difference to the director responsibilities when it comes to leasing personal guarantees as the company is likely to be the main debtor and the director will typically sign as a guarantor. However, it may be that there are more settlement options available.
In the main, finance companies are generally easier to deal with and not as aggressive as suppliers when looking at lease personal guarantees, regardless, the key is to get them onside as quickly as is possible. Relationships count for a lot so keep on your account manager’s good-side.
Lease agreements are generally long-term rental agreements without an asset value and we are assuming that this is the case for the purposes of this page. If there is an asset value (via lease purchase for example) then look under Hire Purchase below. It is also worth understanding the agreement is very unlikely to be a non-participating agreement, so not covered under the consumer protection act. The bottom line is you as a director will not have the same protection.
Lease personal guarantees from an insolvency perspective are more easily dealt with as any liquidator is unlikely to have an interest in them as they do not normally provide an asset value and are usually a liability. In this case, the director is considering to trading and may want to take the van/car lease with him/her to the new business for example. Provided you can get the finance company to agree to this arrangement called ‘novation’, this solves the lease personal guarantee issue.
If you cannot ‘novate’ the agreement then we can try to see if the finance company will waive the right to pursue the lease personal guarantee in lieu of a new agreement in the new company name assuming that you are starting up again. It may be that the new company will need to pass underwriting, but this is certainly worth a shot in getting rid of the ‘guarantee’ element.
A lot will also depend on what asset has been leased and which company it’s from, so always check the termination penalties in any agreement as they are often not as severe as initially thought, so the lease personal guarantee may be less than expected.
If you are not starting up again, finance companies are usually willing to negotiate terms and we will assist throughout this process and there is no fee for this service when using our Insolvency Practitioners.
Hire Purchase or Finance Lease Personal Guarantees
These personal guarantee agreements are similar to the lease arrangements above when considering transferring across to any new company. There is a key difference, however, if the business is going into an insolvent liquidation, in as much as there may well be an asset value. The simplest way to check this is to obtain a settlement figure from the finance company and then cross reference this against the value of the asset.
It is critical with hire purchase personal guarantee agreements to identify who owns the asset (right to title) and this can often be determined by simply calling the finance company and asking them, or check the agreement, or as a rule of thumb by calculating how many payments have been made. If more than two-thirds of payments have been made, it is likely that the company will have ‘right to title’. The relevance to the personal guarantee is that the directors may be able to sell the assets as opposed to the finance company selling them. A director with a personal guarantee on a hire purchase agreement clearly has a vested interest in obtaining a better return for the asset than the finance company, who will just want to dispose of it as quickly as possible and who also have ‘guarantees’ to fall back on for any shortfall.
The bottom line is that we will check through the agreements thoroughly and assist with any personal guarantee negotiations required.
A top tip is to ensure you always initial every page on any agreement. This ensures replacement pages cannot be inserted at a later date.
Can You Get Out Of Personal Guarantees?
Call 08000 746 757 to speak with a personal guarantee specialist who can help explain the risks and potential elements to be addressed before you liquidate.