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Personal guarantees: What are they for and when are they used?
Personal guarantees (PGs) are commonly required by lenders for all forms of business lending. Typically, the lender will look to the business owner, or one or more of the directors of the corporate borrower, to provide the guarantee. The requirement for such a guarantee poses certain legal and practical challenges and has serious implications for the guarantor.
Here, a member of our dedicated Banking and Finance team, explores the key questions around personal guarantees and the considerations for guarantors.
Why take a PG?
A prime pillar of corporate law is the notion that the officers and shareholders of a limited company are not legally liable for the company’s actions or debts. A creditor cannot, on the face of it, go behind that “corporate veil” of limited liability. Therefore, if a lender provides funding to a business that subsequently fails, it cannot look to the managers and stakeholders to cover its losses. Conversely, where the business turns a profit, the lender has provided a specific amount of funding for an agreed but finite return, whereas the individuals behind the business stand to benefit from those increasing profits. Lenders argue that taking a PG from the owner(s) or senior executives is therefore justified on a risk/reward basis, giving the lender another line of recourse should the corporate borrower fail, thus “piercing the corporate veil”. It also ensures that those individuals remain focused on ensuring both the success of the business, and repayment of the borrowed funds.
What liability does the guarantor take on?
This is the $1m question, the answer being that it depends on what the PG provides. Most high street banks will only take PGs that include an express limit on the guarantor’s liability. This is partly a practical stance on their part – the courts tend to take a dim view of contracts that impose unlimited personal liability on an individual – but many UK high street banks have also signed up to voluntary codes of practice, under which they agree not to take unlimited PGs. Other lenders who are not party to such codes are less scrupulous, and it is not uncommon to see PGs under which the guarantor is taking on liability for all liabilities of the borrower, present and future, to the lender in question.
Even when a PG is capped at a set principal sum, that is not the end of it. It is the classic case of reading the small print: often lenders will issue heads of terms to borrowers, which refer to the need for a PG “capped at £X”. However, the drafting of the PG itself will usually go on to extend the guarantor’s liability to include extra features such as interest, costs, fees and expenses.
What are these additional liabilities?
Again, it’s a question of reading the small print in the PG, but typically the lender will want to charge the guarantor interest on any sums demanded from the guarantor, commencing from the date of demand until payment or earlier court judgment. The PG will specify the rate of interest, commonly the same rate that the lender is charging the corporate borrower. The PG will also set out what costs, fees and expenses the lender can charge the guarantor. These are typically legal costs incurred by the lender in taking the PG, any legal costs incurred during the life of the guarantee in order to protect and/or preserve the guarantee, and costs incurred enforcing the guarantee if the lender has to make demand under it. Those enforcement costs can include things like:
- Enquiry agents’ fees – where the lender instructs agents to make checks on the guarantor’s assets and lifestyle
- Service fees – where the lender instructs agents to serve court papers on a guarantor
- Legal costs – where the lender instructs lawyers to bring debt proceedings against the guarantor
Independent legal advice (ILA)
Most lenders taking PGs will insist on the guarantor receiving legal advice before he/she signs the document. It is also usual for the lender to want that advice to be given by a lawyer that is not also advising the borrower (hence “independent” advice). The logic behind this being that the borrower (and the borrower’s advisor) has a vested interest in the guarantor signing up to the PG, as provision of the PG will be a condition to the lender advancing funds to the borrower. An independent advisor is free from such bias and ought to be able to give impartial advice to the guarantor.
The lender will usually require a certificate from the independent advisor in which he/she certifies that they have held a private meeting with the guarantor during which he/she explained the full terms and effect of the guarantee, and the consequences of giving the guarantee. The certificate will also typically require the lawyer to state that he/she acted for the guarantor in giving the advice.
The requirement for ILA poses certain practical hurdles. Firstly, the guarantor will have to find a lawyer willing and able to give the advice. Not all solicitors’ practices are willing to provide ILA, as it is a question of risk and reward: the guarantor will not want to pay a large fee for what he/she may consider to be an unnecessary inconvenience, but the solicitors’ practice is taking on liability to the lender in providing the advice certificate. If the guarantor is not already an existing client of the solicitors’ practice, there will also be the hurdle of satisfying anti-money laundering proof of identity and address checks, which will be a pre-requisite to any advice being given. During the current Covid-19 pandemic, face to face meetings are not always possible or desirable, and that might mean that the ILA must be done via a video conferencing facility which, in turn, may mean changes need agreeing to the wording of the advice certificate that the lawyer has to provide in order to explain how the advice was given, and how the guarantor’s execution of the PG was witnessed.
It is also worth noting that the guarantor will be the client of the solicitor giving the advice, and therefore responsible for that lawyer’s costs. The borrower company might agree to reimburse the guarantor for such costs, but the lawyer’s bill will be addressed to his/her client – the guarantor personally – and therefore, if the company pays it on the guarantor’s behalf, it will not be able to reclaim the VAT as the service was provided to the guarantor, not the borrower.
So how are PGs enforced?
Part of the ILA process ought to include a discussion on the consequences for the guarantor in providing the PG. PGs are usually drafted so that they become enforceable upon the lender serving a written demand for payment on the guarantor. Usually, interest will start running on the sums demanded from that date onwards. If the guarantor fails to satisfy the demand by making full payment within the time specified in the demand, then the lender has several options available to it:
- it can continue to demand payment either in person or via a debt collection agent;
- it can commence debt proceedings in the courts with a view to obtaining a monetary judgment against the guarantor for the sums owed or;
- it could serve a statutory demand which, if not set aside within the specified time period, would allow the lender to go on to commence bankruptcy proceedings against the guarantor.
If the lender has chosen to proceed via the courts and obtains a monetary judgement, it can then apply to the court for certain enforcement actions, including:
- instructing the court bailiff or sheriff to seize the guarantor’s personal effects in order to sell them and use the net proceeds to repay the debt;
- ordering any debtor of the guarantor to pay the sums it owes direct to the lender;
- obtaining an attachment of earnings order so that any employee of the guarantor has to pay sums to the lender directly from any salary due to the guarantor or;
- seeking a charging order in order to secure the debt against any interest the guarantor has in a property.
The charging order option means that the guarantor could be forced to sell his/her home, even where the property is jointly owned with the guarantor’s spouse. Once a charging order has been made by the court, the court can make an order for sale in order that the debt can be repaid from the guarantor’s share of the net sale proceeds.
Summary
PGs are a common feature of business lending but ought not to be treated lightly. A guarantor ought not to view the requirement to take ILA as an inconvenient expense, but as an opportunity to ensure that the liability he/she is taking on via the PG is what he/she was expecting, and that he/she fully understands the consequences to him/her personally by providing the PG.