Following the 2008 financial crisis, High Street banks commonly insist on personal guarantees to back commercial loans, particularly to smaller and medium-sized businesses (SMEs), in addition to security given by a borrower. This makes the ‘Guarantor’ (usually a business director or owner) personally liable for the borrower’s debt. If the borrower defaults, the bank can go after the Guarantor’s personal assets, including the family home.
Many SME owners are unaware about the level of risk involved with personal guarantees. A 2016 Wirefund (an SME loan provider) survey discovered 79% of SME owners had not been dissuaded from taking out a business loan because of a personal guarantee and 55% of those SME owners did not understand what personal guarantees were. Many SME owners, therefore, sign personal guarantees without understanding the extent of liability and the risks involved.
Personal guarantees typically involve three parties: the ‘Lender’ (usually the bank), the Principal (usually the business), and the ‘Guarantor’ (usually a director/owner of the business) who makes a contractual promise that the loan will be repaid to the Lender by the date required. Guarantors should be aware that, when well-drafted and legally watertight, personal guarantees are highly effective debt collection devices. Often requiring full liability by the Guarantor, personal guarantees can cover all assets (including any property, cars, and cash). Although the business is the primary debtor, the Guarantor is next in line. The Guarantor’s liabilities may be capped, for example at the loan amount, but many guarantee documents also include an indemnity requiring the Guarantor to pay costs and expenses, plus interest. Thus, the Guarantor’s liability may be far higher than any capped amount stated.
Pursuant to recent case law, banks commonly insist that ILA is obtained. In the 2001 landmark case of RBS v Etridge, multiple guarantors avoided repossession of their homes by successfully arguing the personal guarantees given were unenforceable because of undue influence. The House of Lords consequently gave guidance to banks to insist a Guarantor:
- attends a private meeting with the bank for advice on the liability/risks and suggest ILA is sought; or
- obtains ILA.
To ensure personal guarantees are enforceable, lenders generally require ILA to be given by a qualified advisor, typically a solicitor.
Before giving a personal guarantee, you should explore all other potential credit routes to avoid personal exposure. If a personal guarantee is unavoidable, Guarantors should:
- take legal advice from the outset;
- carefully read the contract; and
- attempt to limit the scope and wording of the personal guarantee
and indemnity – it may be possible to negotiate a financial or temporal cap.
The cost of such ILA often falls to Guarantors and they should be mindful of this.
You should ensure a full and accurate record of all personal guarantees is kept (the borrower should also maintain a list). Personal guarantees are not automatically released when an individual’s involvement with the borrower ceases, for example on a business sale or a director’s resignation. A formal release must be obtained otherwise personal liability will subsist, exposing the individual to risk, despite having no influence over the borrower.
If you are considering entering into a personal guarantee or require assistance in relation to enforcement, you should obtain legal advice at the earliest opportunity.
For specialist advice, email email@example.com.