When applying for credit or finance, it is common practice for lending institutions to request a ‘personal guarantee’ as additional security. This article will explain what these guarantees are, and the potential risks of signing one.
Personal Guarantees Breach the Corporate Veil
If you are a director of a limited company, or a partner in an LLP, then the business you are running is a legal entity in its own right, completely distinct from your own personal finances. The idea of this ‘limited liability’ is that, if the company becomes insolvent or runs into debt, you will not risk your own assets. This clear delineation between corporate and personal finances is known as the ‘corporate veil’, a legal barrier designed with the protection of the individual in mind.
What personal guarantees are designed to do, therefore, is to breach this ‘corporate veil.’ When a financial institution cannot obtain sufficient security from corporate assets, it requests a personal guarantee which is often a director’s house, for example. Once this is signed, the lender knows that it’s money is secure whatever unfolds with the business.
Many Directors Fail to Consider the Worst-Case Scenario When Signing a Personal Guarantee
Many personal guarantees are signed during periods of company growth, with an atmosphere of optimism in the air. This absolute faith that the business will succeed gives directors the confidence to put their own assets on the line but, as many have discovered to their regret, there’s no fool proof way to predict the economic future.
If a company becomes insolvent and the bank calls in a loan, the signee may find that the protection offered by the limited company or LLP structure matters little: the bank has every legal right to repossess your house. For directors or partners already facing end of their business, this makes matters significantly more serious.
For this reason, we recommend considering insuring your personal guarantee which can bring with it a lot of peace of mind should the company become insolvent.
Use Our Personal Guarantee Checklist Before You Sign on the Dotted Line
- Before agreeing to a personal guarantee, ensure there is no way the company itself can provide security. The best way to avoid the risks entailed with a personal guarantee is never to sign one in the first place, or to take adequate insurance.
- If a guarantee is called in but proves insufficient to cover the corporate debt, directors could not only lose their house but be forced into bankruptcy.
- Where several directors have agreed to a personal guarantee or sign a single guarantee with joint and several liability, the financial institution may not take legal action against everyone, but single out one individual.
- A third-party charge document combines both a personal guarantee and security over assets. If you are considering signing one of these, ensure that you sign a ‘non-recourse’ third party charge which caps your liability to the value of the charged property, as opposed to leaving it ‘unlimited.’
- Some companies ineligible for finance avoid the risks of personal guarantees by choosing alternative options such as invoice finance.