The Consequences of Director’s Personal Guarantees in Liquidation and Insolvency
Company directors are routinely asked to provide personal guarantees when securing a loan or other finance arrangement. But what happens if the company runs into financial trouble and cannot pay back its debts?
In these situations, the impact of providing a personal guarantee can be severe. If the company goes into liquidation or insolvency, directors may find the corporate insolvency having seismic impacts on their personal finances.
This article will explore the potential consequences of director personal guarantees in liquidation and insolvency. We’ll explain personal guarantees, how they’re impacted by liquidation and insolvency, and what directors can do to manage the associated risks.
If you are worried about your business and how that will impact your own personal liabilities under a personal guarantee, please do contact us. We are very experienced in helping sme directors in these situations.
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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 the guarantor agrees to perform it instead should the principal not fulfil its obligation.
Signing a director’s personal guarantee is referred to as ‘piercing the corporate veil’, which means that, in the case of insolvency, the guarantor has the right to come after your personal assets.
The impact of liquidation on personal guarantees
Liquidation, or any insolvency procedure, may make the finance provider a creditor, meaning they have the right to call in the personal guarantee, dependent on the terms of the agreement. Please check the terms of your personal guarantee to confirm.
If the debt outlined within the personal guarantee agreement is satisfied via the insolvency process (before the ‘crystallization’ of the personal guarantee), this may negate the requirement for the liability being placed with the director personally.
However, it is important to examine the specific terms of the personal guarantee contract if you are in any doubt.
Some agreements with lenders may include terms which state that a company entering into liquidation is sufficient to crystalise the personal guarantee and, therefore, this would place liability with the director from that point onwards.
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 carefully check the wording in your facility agreement carefully to ensure the terms apply to what you signed.
Following 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 has their own contracts, they ensure they are watertight 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 negotiate a settlement figure less than the amount guaranteed.
Possible grounds for a 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?
- Has 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 can manage the risks associated with personal guarantees by seeking professional advice before providing a personal guarantee, obtaining personal guarantee insurance, or negotiating the terms with lenders to cap the liability.
How enforceable are personal guarantees?
Generally speaking, personal guarantees are highly enforceable, requiring specific circumstances and the services of an experienced lawyer to get out of.