When your business is set up as a limited company and you start having financial difficulties, it’s common to start worrying about any personal liability if the business fails. Many small company directors have given personal guarantees to support the business growth and borrowing.
Under this stress, there can be a tendency to double down or make rash and unwise decisions, such as to continue trading when insolvent or to first pay off a creditor who has the guarantee, with a view to removing the chance of your personal guarantee being enforced.
Any action of the type described above will only be likely to compound your problems and legal risks. A clear head is needed and this often means seeking good, experienced advice. Things are not always as bad as you think and there is often a chance to negotiate and avoid your worst case scenario.
Below we explain how director’s personal guarantees are treated in insolvency events and whether there is any way out of them if your business has to liquidate.
What is a Directors Personal Guarantee?
Directors personal guarantees are legal contracts commonly signed to guarantee corporate finance for a business in which they are involved.
In a guarantee, the guarantor promises the lender that, in the event of the principal not performing its obligation, the guarantor agrees to perform it instead.
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.
Directors Guarantee in Insolvency
Director’s guarantees will be called in during corporate insolvency by the creditor holding the charge, typically a bank.
This means that in most cases the director will be personally called upon to pay the liability guaranteed.
Liquidation and Personal Guarantees
In the vast majority of cases a liquidator (appointed insolvency practitioner) will not be able to advise you on what action to take. While insolvency practitioners have a duty of care towards the directors, they are primarily acting for the creditors (the people your business owes money to). Because they have a responsibility to the very creditor you have a personal guarantees with, they cannot advise you personally by law.
In most cases, and unless there are strong grounds for contesting the guarantee – plus the legal support to do so – directors will be expected the pay the guarantee, or file for bankruptcy if they cannot.
If you choose to contest the guarantee you should choose an experienced solicitor with particular experience in this area.
Can Directors Get Out Of A Personal Guarantee If The Business Is Insolvent?
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.
Is there a Personal Guarantee legal loophole?
It may be possible to challenge the enforceability of a personal guarantee and/or to negotiate a settlement figure which is less than the amound guaranteed.
Possible grounds for challenge might 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.