The increasing requirement for personal guarantees – what you need to know

A personal guarantee, also known as a director’s guarantee, is where an individual enters into a personal responsibility to comply with loan obligations should a borrower company default.

The guarantor is usually a director of the borrower entity. When a lender provides a loan to a company, one of their increasingly common requirements is to request additional security by way of a guarantee and indemnity. A guarantee requires the guarantor to personally guarantee the loan obligations, whilst the indemnity requires the guarantor to indemnify the lender against all default on the part of the borrower.

Why a guarantee is common

Without a guarantee, a lender can find themselves in a position where they could loan money to a company that then wound itself up or became struck off. In this instance, the potential for the lender to recover monies is low. The introduction of a personal guarantee means that a lender can obtain an additional level of security, should they need to enforce the terms of the loan. Where a borrower company does not repay its debts or does not perform its obligations (such as keeping a property in good repair or insured), the lender is able to pursue the guarantor for that non-compliance.

When a guarantee is common

The requirement for a guarantee can form part of the overall security package a lender gives when providing a loan.

Situations where a guarantee can be requested include:

• Commercial or residential loans (to assist with refinance or purchases)
• Asset finance
• New leases where a landlord requires collateral

Considerations for the lender

Enforcing security against corporate entities can be time consuming and expensive, particularly where a borrower company is wound up or going through administration or liquidation. A guarantor is usually an individual, compared to a corporate, and are typically much easier and quicker to pursue for unpaid amounts.

Considerations for the borrower

The borrower company should recognise that the corporate entity is a distinct legal personality. The directors, although in control of the day-to-day running of the company, are separately recognised individuals in the eyes of the law. There are no real cons to a borrower company when it comes to a director’s guarantee, as it acts as a fall-back method of security for the bank to enforce if the borrower itself defaults.

Considerations for the guarantor

There is a huge personal liability for the guarantor. The guarantor should be aware of the risk of losing personal assets, like their home, should the level of borrower default be high. Guarantors should seek to have their liability capped under any guarantee to give a modicum of certainty. It is also imperative that a guarantor is released from the guarantee if they are a director who ceases to be involved in the company/business being guaranteed, this will not happen automatically. A guarantee and indemnity supersedes death, so a guarantors Estate will be left to deal with enforcement of the personal guarantee even if the guarantor has passed away. A lender will almost always require the borrower to take legal advice before entering into the guarantee so that they are aware of these consequences.

Conclusion

There is an obvious conflict of interest in what is in the borrowers’ best interests, and what is in the guarantors. Owing to that potential conflict, a lender will typically require a guarantor to take independent legal advice from a separate firm of solicitors than those appointed to act for the company in the loan transaction. High Street lenders are more commonly allowing the same firm to act for both borrower and guarantor, provided that appropriate safeguards and controls are put in place to mitigate the risk of a conflict of interest, such as different offices acting for each party.

How Pinney Talfourd help

Our experienced Company & Commercial team can assist with providing the required independent legal advice to guarantors or providing tailored guidance and support to companies and lenders that are considering obtaining a guarantee.

Contact our Company & Commercial team on 01277 211 755 or get in touch by emailing our team on .