Many lending institutions ask for a personal guarantee when considering business loans. This seemingly simple step can have significant consequences for your personal finances. While the excitement of a new venture might cloud your judgment, it’s crucial to understand the risks involved before signing.
For established companies, it’s crucial to check if you’ve already provided a guarantee to the lender. Many personal guarantees are “all monies” agreements, meaning they cover both current and future debts. This can lead to unnecessary additional guarantees if your existing one already covers new borrowing.
If a lender insists on a new guarantee, negotiate the termination of any existing ones to avoid being liable for the same debt multiple times. Remember, these requests might be routine procedures rather than a genuine need for extra security.
I’ll cover the risks involved below.
Risk
Description
Unlimited Liability
Entire personal wealth, including your home, is at risk. Covers original loan, future debts, interest, and legal costs.
Risk to Personal Assets
Personal assets, especially your home, can be seized if the business defaults.
Ongoing Liability
Liability persists even after loan repayment or leaving the company, unless explicitly cancelled.
Impact on Personal Credit
Defaults or late payments affect your personal credit score.
Difficulty in Release
Hard to negotiate release; liability may continue after selling or exiting the business.
Immediate Loan Repayment
Lender may demand full repayment at any time if they perceive financial instability.
Further Costs
May be liable for lender’s additional costs, including legal fees and penalties.
Unlimited Liability
Unlike the nominal guarantee in companies limited by guarantee, personal guarantees typically have no cap on potential liability.
This means the guarantor’s entire personal wealth, including their home, becomes vulnerable to creditors’ claims. Furthermore, the guarantee often covers not just the original loan, but also future debts, interest, and potential legal costs.
Risk to Personal Assets
While any personal asset can be used, the typical collateral used as a guarantee is a director’s house.
This can result in the forced sale of the property, potentially leaving the director and their family without a place to live.
While the family home is often the primary concern, other personal assets are also at risk. These may include:
Savings accounts
Investments
Valuable possessions
Ongoing Liability
The risks of signing personal guarantees can persist even after the original loan is repaid or the director leaves the company unless the guarantee is explicitly cancelled.
In scenarios involving multiple directors, each guarantor may be held jointly and severally liable, potentially responsible for the entire debt, not just their proportional share.
An important case illustrating this was National Westminster Bank plc v Lucas and Others [2014] EWCA Civ 1632[1]Trusted Source – Judiciary.uk – National Westminster Bank plc v Lucas and Others [2014] EWCA Civ 1632, where the court upheld the principle of joint and several liability resulting in the guarantors being held liable for the entire debt, even after the insolvency of another guarantor.
Impact on Personal Credit
Another area where the signing of a guarantee can impact you personally is if there are any late payments, defaults, or legal actions related to the guaranteed debt. These will be reported to credit agencies under your name and can impact your personal credit score.
Difficulty in Negotiating Release
As many directors discover to their chagrin, negotiating a release can be challenging once you have signed.
Lenders often have little incentive to release a personal guarantee, as may be reluctant to relinquish this extra layer of protection, particularly if the company’s financial situation has deteriorated since the guarantee was signed.
Even if you sell your stake in the company or transfer ownership, the lender may still hold you liable. The terms of the guarantee often don’t terminate upon changes in ownership or management, leaving you responsible for the debt even after you have exited the business.
Risk of Immediate Loan Repayment
When you provide a personal guarantee for a business loan, the lender may include a clause that allows them to demand immediate repayment of the loan at their discretion. This means that if the lender perceives a change in the company’s financial stability or creditworthiness, they can require the loan to be repaid in full, even if the company is currently meeting its payment obligations.
Further Costs and Liability for Lender Losses
In my experience, one of the least known risks is that your liability may extend beyond the principal amount of the loan. In some cases, you may also be responsible for covering additional costs incurred by the lender in their efforts to recover the debt.
These further costs can include:
Legal fees
Interest charges
Debt collection costs
Penalty fees
It’s crucial to carefully review the terms of the personal guarantee and the associated loan agreement to understand the full extent of your liability.
Important Clauses to Review in the Personal Guarantee
When reviewing a personal guarantee, it’s crucial to pay close attention to several key clauses that can significantly impact your liability:
Payment Obligation: This clause defines the extent of your liability. It may cover all outstanding debts of the business or be limited to a specific amount. Be particularly cautious of clauses that include interest and legal costs on top of the principal.
Duration and Termination: Look for clauses specifying the guarantee’s term and any conditions for its termination. Some guarantees persist beyond loan repayment or your departure from the company. Seek clear termination conditions to avoid indefinite liability.
Demand for Payment: Check if the guarantee allows the lender to demand immediate repayment at their discretion. This could force you to repay the full amount even if the company is meeting its obligations.
Caps on Liability: While not common, some guarantees may include a maximum liability amount. If present, ensure this cap is clearly defined and understand any exceptions.
Indemnity Clauses: These extend your liability beyond the loan amount to cover the lender’s losses or expenses. Be cautious of broadly worded indemnities.
My advice is to carefully review these clauses with a legal professional to fully understand your obligations and potential risks before signing.
Taking Personal Guarantee Insurance Mitigates Your Risk
Personal Guarantee Insurance (PGI) is an annual insurance policy that can help mitigate the risks associated with providing a personal guarantee. PGI is designed for directors of limited companies or partners of an LLP who have provided personal guarantees for business loans.
PGI offers protection by covering a fixed percentage of the guaranteed amount, providing a safety net if the lender calls upon the personal guarantee. The insurance is regulated by the Financial Conduct Authority (FCA) and is available for personal guarantees taken against both secured and unsecured loans.
While PGI can offer valuable protection, it’s important to remember that it does not eliminate all risks associated with personal guarantees. It is still crucial to carefully consider the implications of providing a guarantee and seek professional advice before making a decision.
References
The primary sources for this article are listed below, including the relevant laws and Acts which provide their legal basis.
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