Personal Guarantees and Insolvency. What Directors need to understand
Owners and Directors of small and medium-sized businesses and start-ups are often required to sign Personal Guarantees in order to secure funding and supplies from, for example, Banks, Asset Based Lenders (‘ABL’s’), Landlords and Trade Suppliers.
Should you face corporate insolvency, a Personal Guarantee can put all the Director’s personal assets at risk, including the family home. When it comes to Personal Guarantees and insolvency, Director’s should always take independent legal advice before signing one to ensure that you understand your liability and the extent of the risk involved.
Why might you be asked to sign a Personal Guarantee?
Raising money to create or invest in your business can be difficult if it is a new venture without evidence of successful trading to show the bank or potential investors. In this situation, it is common for a Personal Guarantee to be requested, for example, when seeking investment, an overdraft facility, a property loan or trade credit.
Such a guarantee document is an agreement to take personal responsibility for a debt in the event that it is not repaid by the company, by using personal assets to pay the debt and any other money accruing (interest, costs etc), if the Personal Guarantee is called in.
Mitigating the risk – capped liability and insurance
It is important to fully understand the extent of a Personal Guarantee Agreement before signing it and, if possible, agree on a cap. This will limit the amount that can be claimed in the event of difficulties and means that Directors know exactly how much stands to be lost in a worst-case scenario (e.g. insolvency).
There may also be the option of taking out Personal Guarantee Insurance, which could potentially allow you to avoid bankruptcy and the loss of your personal assets.
Obtaining legal advice before signing
Because of the onerous nature of a Personal Guarantee, everyone who signs it should first take independent legal advice. A bank or building society will often require this to be done as part of the process of entering into the agreement, trade creditors and landlords may not. If you waive your right to take independent legal advice, you may not be able to rely on this to try and avoid the Guarantee Agreement.
The agreement itself should be as specific and detailed as possible, setting out exactly what is covered by the Personal Guarantee, any limit on liability and the agreed processes for repayment and calling-in of the monies owed. This will help avoid future disagreements and will also give the Director clarity as to what is likely to happen and what is expected from the Director and when.
Did a spouse or partner sign the Personal Guarantee?
If a spouse or partner has signed as a Personal Guarantor without first taking legal advice, they should take legal advice if it seems likely that the guarantee will be called in. If they are not personally involved in the business but may lose their assets, this should have been explained to them beforehand. If it was not, they may have a defence or be able to make a case to save their property (or at least have ammunition to argue with the creditor).
What happens when a Personal Guarantee is called in?
The process can vary. You should ensure that the creditor adheres to any terms within the guarantee document when calling in the debt. The most usual route that a creditor will follow is either issuing a Statutory Demand or issuing a claim to the County Court for a Judgment.
A Statutory Demand will give 21 days in which to pay the outstanding amount or alternatively to reach an agreement with the creditor over repayment failing which you may be at risk of bankruptcy proceedings.
If a creditor makes a successful claim to the Court for a Judgment, then they will be able to obtain a Warrant of Execution, allowing bailiffs to seize goods, or a Charging Order which will allow them to register a Charge against your property.
Challenging a claim made pursuant to a Personal Guarantee
If you are facing the possibility of a Personal Guarantee being called in, you should take legal advice as soon as possible. Even where the creditor is a bank or other financial institution, it may still be possible to make a successful challenge. The grounds of challenging a Personal Guarantee will depend on the circumstances of the particular case.
The Director and his Solicitor need to consider in detail the terms of the Personal Guarantee, how and where it was signed and by whom and the advice that was given (if any) before signing. We can advise as to whether there are any defences available to you and whether the liability can be reduced in any way.
Personal Guarantees and Insolvency – a recent success
We successfully applied to Court for the Director Guarantor, to set aside a Statutory Demand where the Personal Guarantee had been signed off at 11.00pm in a car park on the M1, against the backdrop of wages needing to be paid the following day.
Challenging a claim can involve complex issues of law, including equitable principles and unfair terms. The creditor is also required to go through a set process in enforcing the Personal Guarantee and if they do not carry this out correctly you may be able to challenge them.
Take a look at our article on Defending and Reducing Personal Guarantee Claims for more, written by our consultant solicitor, Iain McDonald.
What to do if your business is facing insolvency?
If your business runs into difficulties, you should start to look at your options as soon as you can rather than leaving the situation to grow worse. That may involve the involvement of a trusted Licensed Insolvency Practitioner who can advise on all options. If you are unable to repay a debt that is due, you may be able to negotiate with your creditors. They may be willing to work out a payment plan with you to avoid enforcing the guarantee through the Courts, which could be expensive and time-consuming for them and might not in any event mean that they recover all of the debt.
Be aware of the order in which you pay off the money you owe to your creditors if your company becomes insolvent. If you pay a Personal Guarantor ahead of other creditors, you may be in breach of the Insolvency Act 1986. This sets out a strict order in which creditors should be paid, and sets out restrictions on amongst other things, preferring one creditor over another.
Because of the complicated nature of challenging a Personal Guarantee agreement and the high stakes involved, it is advisable to seek professional advice on the best approach.
As well as challenging the claim, we can also explore alternative dispute resolution. It is important for parties to a dispute to consider alternative dispute resolution at all stages.
Summary
As many businesses face disruption in the current global turmoil, financial difficulties will arise for both borrowers and creditors. It is likely that Personal Guarantee agreements may be called upon as the economy struggles.
It is essential to address problems as soon as they arise, working out a long-term plan to deal with and overcome them. Creditors will be reassured to see that you are facing the situation and that you have a well thought out approach to difficulties.
If you are facing corporate insolvency, then by working with your creditors, you may be able to find a solution that means you can avoid losing personal assets, such as your home. It is often in everyone’s interests to save a business, so you may find that your creditors are willing to negotiate. But if you avoid the situation, they may feel that their only option is legal action.
If you are specifically concerned about a Personal Guarantee you have signed, or your business is facing financial pressure or even insolvency, contact the team at Neil Davies and Partners for a free and no obligation confidential consultation.
Frequently Asked Questions
- Does my liability end if I resign as a Director?
No. A common misconception regarding Personal Guarantees and Insolvency is that resignation terminates liability. You remain personally liable for any debt secured by the guarantee until the creditor provides a formal, written release. If you are leaving a business, it is vital to negotiate your release as a guarantor; otherwise, you may find yourself pursued years later for the company’s subsequent failure.
- Is it possible to obtain Personal Guarantee Insurance after financial trouble begins?
Generally, no. Personal Guarantee Insurance (PGI) is a proactive risk-management tool designed to cover a significant portion of your liability. However, most providers will not offer cover if the company is already showing signs of distress or facing insolvency. To protect your personal assets, these policies should be implemented while the company is in a stable financial position.
Not necessarily. While a CVA or Liquidation deals with the company’s liabilities, the Personal Guarantee is a separate contract between you and the creditor. Unless the specific terms of the insolvency procedure or a separate deed of release state otherwise, the creditor can still pursue you for the shortfall. This highlights why understanding the intersection of Personal Guarantees and Insolvency is critical for any director facing corporate recovery.
