Key points for directors to consider before giving a personal guarantee.

Has your limited company been offered a loan but on condition that you sign a personal guarantee, as the director? Key points to consider before giving a personal guarantee.

With the LSB recently updating its Standards of Lending Practice for Business Customers to provide stronger protections for small and medium-sized enterprises (for more information on this, see LSB announces stronger protections for personal… | Carson McDowell (carson-mcdowell.com)), it seems like an appropriate time to discuss personal guarantees and highlight key considerations for directors before providing one.

What is a director’s personal guarantee?

A personal guarantee is a legally binding agreement between a lender and a company director which, when entered into, means that the director will be personally liable for repaying the loan if the company defaults on its repayments.

What does personally liable mean?

Being personally liable means that if a company is unable to re-pay the lender, the director will be required to use their own money, or if funds aren’t readily available then their assets, to pay off the company’s debt. The director cannot refuse to do so as once a personal guarantee is in place, there is no way to retract the guarantee without causing a default on the loan, other than to settle the debt or re-negotiate the terms of the guarantee, or the loan, with the lender.

If the director defaults on their personal guarantee, not only could it negatively affect their credit rating, but the lender may pursue legal action against the director personally, whether it be for breach of contract or more likely personal bankruptcy, which could result in the seizure of assets and disqualification from future activities as a company director.

Questions to ask before signing a guarantee:

1. How much money could the guarantor be personally liable for? - if the company cannot pay its debt and defaults, then this could be the amount which the director is required to pay to settle the loan. The director should consider negotiating a cap on the guarantee so that they aren’t liable for the full amount. This is especially important if the lender is able to make further advances to the company, which without a cap would increase the director’s liability. Many mainstream lenders will agree to a cap, particularly if they subscribe to the LSB’s Standards of Lending Practice.
2. Could the guarantor be responsible for costs? – even if the director is able to negotiate a cap on their liability, they may still be liable for any enforcement costs which the lender has incurred in pursuing the company’s debt or for the interest on overdue payments. These costs are often uncapped, and the director should be sure that they can pay these costs if demand is made.
3. What constitutes a default and is there a remedy period? – on an event of default, the lender may be able to demand the repayment in full and will look to the director who provided a personal guarantee if the company is unable to pay. It is therefore important to understand the specific actions which result in a default and what the lender’s rights are if this occurs. The inclusion of a remedy period would be beneficial as it prevents a lender from demanding the full payment until the company (or if it can’t, the director) has a chance to make the due payment(s).
4. Does the guarantee state that the lender can only make personal demands from the director as a last resort? – it may come as a surprise that most personal guarantees will not require a lender to pursue or exhaust all remedies against the company before calling in a guarantee. Most guarantees allow a lender to call for the guaranteed sum to be paid at the same time as the debt is demanded from the company. In practice, there is likely to be engagement by the lender with both the company and the guarantor before any demand, however, that is not likely to be a strict requirement under the guarantee.
5. How long will the guarantee remain in place? - it is in the director’s interests for the guarantee to fall away when certain financial tests are met, for example if the company have re-paid more than 50% or 75% of their loan back. If such a clause is not included in the guarantee, it may be possible to limit the director’s period of liability to a specific timeframe. In the absence of a fixed or defined timeframe for release, the guarantee may remain in place indefinitely.

As this article has outlined, being personally liable for a company’s debts could have serious financial repercussions. If a director is considering signing a personal guarantee, it is important that they check the terms of the guarantee, understand what they mean and think about how they might affect them financially, should the guarantee be enforced.

If you would like further information, please contact Kerrie Emerson or another member of the Banking and Finance team.

*This information is for guidance purposes only and does not constitute, nor should be regarded, as a substitute for taking legal advice that is tailored to your circumstances.