Directors must always be wary of Personal Guarantees when borrowing money, especially when ‘alternative lenders’ are involved.
One of the first questions we ask directors of insolvent companies is whether they have any Personal Guarantees (PG) on outstanding loans. The answer is often no, and yet, we quickly discover that many of them do. In this article, one of our partners, Nitin Joshi, looks at Personal Guarantees and how often Directors don’t know – or forget – they have one. The consequences can be extremely serious. He also suggests that directors should tread with particular caution when raising funds from alternative lenders, where Personal Guarantees are common.
Directors are not shielded by the corporate veil at insolvency when a Personal Guarantee is involved
It is commonly understood that when companies enter an insolvency procedure, their debts are administered by the office holder, usually a Liquidator who is a Licensed Insolvency Practitioner. That is the legal framework.
It then follows that directors are not personally liable for company debts, doesn’t it? Directors believe that the corporate veil is their comfort blanket which will shield them against stormy weather.
Directors can be held personally liable for debts covered by a PG
Except this is not always the case. Often, to the shock of directors, they may have given Personal Guarantees (PGs) to suppliers and lenders, paperwork they have signed probably when the sun was shining and their start up universe was bathed in rays of optimism.
Only, as we all know, life is anything but a smooth journey.
When calamity knocks on the door, and the company is insolvent, people like us are consulted. Rightly, the focus of these early discussions is about the company itself, its financial position, cash flow, pipeline and something that focuses the mind in particular – creditor pressure. The question that should always be the first one is can the company be salvaged?
But where last rites are required, and Liquidation is the likely outcome, an area that is all too seldom discussed is the director’s personal position. The dreaded Personal Guarantee. Which is why it’s one of the first questions we ask.
It is extraordinary how often directors simply don’t know, or forget, that they have these swords of Damocles hanging over them. If they are enforced, the director becomes personally liable for the debt, and that can cost a director their house and any other asset – cars, savings, investments, etc., – in order to be able to repay, or possible bankruptcy if not.
Directors must beware of agreeing to Personal Guarantees and always scrutinise Ts and Cs
Agreeing to a Personal Guarantee, without necessarily knowing that there is one there is easily done. Somewhat cunningly, some suppliers bury PGs into their terms and conditions or embed them into their trade credit account application forms. In a sense, directors have no choice, because cash flow is a transitional issue, that is, they need trade credit because their customers do not pay on time, usually well beyond the standard 30 day terms. To alleviate that cash flow squeeze, most businesses seek a combination of trade credit, bank overdraft or invoice discounting.
All these devices commonly require PGs.
It should be a lightbulb moment. To give or not to give (a PG). The temptation to give is too great. The burning fire of entrepreneurship, the trading gene in a business creator can’t take no for answer, compelled to get over the line and became a profitable enterprise – fortune favours the bold.
The ugly business of the PG comes to the fore when the principal debtor (the company) enters an insolvency procedure.
And so begins the chase. Guarantors are asked by the lender to settle in full, usually in a letter, most of which is an exercise in stating the obvious, that is, the fact there’s a PG in place.
Guarantees may be for a limited period, directors are usually jointly and severally liable, although it could be that not all directors have signed, and the holders may choose who to pursue, possibly not equally. But, whatever the situation, there are traumatising moments for the Guarantors when insolvency strikes.
What about Alternative Lenders?
As the British Business Bank has pointed out recently, alternative lenders and private debt funds have filled the gap left in the UK small business finance market after the mainstream banks scaled back their lending post Pandemic. However, data from Purbeck Personal Guarantee Insurance shows that this has come at the cost of an increase in the requirement for Personal Guarantees, even for loans of below £10,000.
If a business becomes insolvent, these business debts could affect your personal assets if you are unable to pay them in full
Should the worst happen, and the loan cannot be repaid and insolvency strikes, our experience is that these Personal Guarantees are being aggressively pursued, significantly affecting the personal finances of directors at liquidation, not to mention their credit score and report going forwards.
Again, caution is the watchword.
Some key considerations for directors if a Personal Guarantee is called in
- Was the director required to seek independent legal advice?
- Is the amount actually correct? Can it be disputed? Are there any exemptions?, Is there any mitigation, for example, if the advance to the company was securitised? Have the assets under that charge been sold and the proceeds deducted from the claim?
- Could the directors have been misled?
- Does the PG terms unfair? If yes, it could be challengeable under the Unfair Terms in Consumer Contract Regulations (1999).
As always with these things, directors should seek the best possible advice, from an accountant and/or a solicitor, when considering whether to agree to a Personal Guarantee.
How can Insolvency Practitioners help?
Whenever a company is in considerable financial difficulty, and is struggling to pay its debts, the directors should seek help from a Licensed Insolvency Practitioner. We will provide detailed and expert advice as to the best course of action whilst also answering questions regarding the liabilities and formalities involved.
If all, or some of the company’s debts are secured by a personal guarantee, the director(s) are liable to repay the debt and it is likely that creditors will try and call on the guarantee. That’s where we come in – we will work towards a solution that all parties can accept, including the possibility of constructing a repayment plan that is acceptable to all parties.
Finding other ways to deal with business debt
Perhaps the most important thing Insolvency Practitioners can do is try and ensure that the guarantee is not called in (e.g. by avoiding business insolvency) and that means seeing if we can we find a way to save the business. Two options could be either a Company Voluntary Arrangement or a Company Administration. If, however, the company is not viable and cannot be saved the option may be to go into Liquidation.
We can then help business owners / directors negotiate with the creditor who has insisted on calling in the guarantee and try and come to some sort of negotiated settlement. As always, the sooner action is taken the more options there are available.
