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 document that bypasses the limited liability status of a limited company during debt recovery.
In such cases, the company directors’ personal assets are at risk as they become liable for the relevant business debt.
Below we’ll cover how director’s personal guarantees are treated in insolvency events and whether there is any way out of them.
Directors’ Personal Guarantee: Definition
Personal guarantees are legal documents signed by individuals to guarantee corporate finance for a business in which they are involved, commonly as directors.
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.
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 or 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.
Directors’ personal guarantees 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, by default, is not a secured liability. The debt remains unsecured unless it is secured by other means such as
- a debenture on the company assets via fixed or floating charge
- a charge on personal assets such as the family home.
Directors’ Personal Guarantees in Liquidation
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.
Personal Guarantees in Administration
Although administration is intended to provide protection from creditors 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).
An interesting situation arises when, if the creditor (i.e. 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.
What Happens if you Default?
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.
How Enforceable is a Personal Guarantee?
As a legal document (usually with a ‘first charge’ or ‘lien’ over a hard asset), personal guarantees are some of the most enforceable contracts in common usage.
While each financial provider will have their own contracts, they take care to ensure they are watertight in order to protect themselves from legal objections.
Assuming the terms stated in the personal guarantee contract are valid and correct, these are exceptionally tricky to get out of it.
Can I get Out of a Personal Guarantee?
Common tactics a lawyer might use to contest a personal guarantee revolved around actions taken by the creditor which may have rendered the guarantee unenforceable.
They include the following:
- Has the creditor deviated from the original loan terms, perhaps by allowing more time than was specified, or by increasing the loan amount?
- The creditor has behaved negligently with other security held against the same liabilities
- Has the creditor altered the liability of the principal under the loan without informing the guarantor
It goes without saying that challenging a guarantee is only worth doing with the services of an experienced lawyer, the funds to pay legal fees, and a strong argument with supporting evidence.
‘Capping’ 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.