We were recently approached by a client asking if we could help to extricate him from a personal guarantee – a guarantee which, prior to it being called on, he had not realised he had given. By signing the relevant box in a document entitled “Application for Credit Account”, our client thought that he was entering into an agreement pursuant to which his company would be granted credit terms by a supplier, an essential component to the smooth day-to-day running of the company. In fact, he and his fellow directors had also unwittingly agreed “jointly and severally to guarantee payment of all the financial obligations (of the company) due to” the supplier – in effect, a personal guarantee.
Therefore, without being provided with a document calling itself a “Guarantee” or even having his attention drawn by the use of the word “personal” within it, a director may find himself personally liable to pay his company’s debts and if he does not do so when required, he may be taken to court and ultimately face enforcement of a judgment debt against his assets, including the family home. In our client’s case, the devil was in the detail – or, rather, buried in the small print.
Is this commonplace?
It is not unusual in the construction industry for an employer to require a parent company guarantee in order to receive the benefit of some form of security in relation to a company’s obligations. However, banks, landlords or even suppliers may agree to deal with smaller, owner-managed companies only if its obligations are backed up by a personal guarantee from the individuals behind it. This may be particularly pertinent, for example, where a new company is keen to get its business up and running.
If you have ever been asked to provide a personal guarantee by, for example, a bank, you will most likely have been provided with a separate guarantee document which clearly identifies itself as a “Guarantee”. You may also have been required to take independent legal advice on the guarantee.1 In this way, individuals are (or should be) fully aware of what they are signing up to.
However, there is no reason why a guarantee may not be contained within another agreement. Further, if the creditor is not a financial institution subscribing to a particular lending code or adhering generally to best practice, he will not feel bound to comply with any of the “protections” potentially afforded to guarantors under such codes of practice, such as a commitment not to take an unlimited guarantee from an individual and ensuring an individual takes separate legal advice. He may instead require a personal guarantee as standard practice regardless of credit rating and just see if he can get away with it by documenting it in his credit agreement.
In the absence then of reading and fully understanding the implications of the small print, it may prove surprisingly easy to find yourself “on the hook” as a personal guarantor.
What constitutes a guarantee?
The law of guarantees is complicated and the purpose of this article is not to provide an in-depth study of that area of law. However, it is still helpful to have an understanding of what a guarantee is and how it can be given.
A guarantee is an undertaking by one party to another promising to be responsible for the payment of debt or performance of obligations by the person primarily liable. The liability of the guarantor is a secondary obligation which is contingent on the existence (and usually breach) of the primary obligations owed by the principal obligor to the creditor.
The basic requirements of a contract governed by English law apply to the formation of a guarantee: i.e. offer, acceptance, intention to create legal relations and consideration if not contained in a deed. The Statute of Frauds 16772 stipulates that a guarantee must be in writing and signed by the guarantor or a person authorised by it in order to be effective.
Historically, this was to protect against liability attaching to informal communications which may be given without sufficient consideration or expressed ambiguously. Although guarantees are often executed as deeds to overcome any argument about this, recent court decisions have recognised that a series of documents (including emails) is now capable of forming a guarantee.
The name of the guarantor in an email, where there is both an intention that it is a signature and an intention to contract, will constitute a signature for this purpose.3
A guarantee can be either
(i) all monies – i.e. guaranteeing all the payment obligations (whether existing or future) of the principal obligor (this is the most beneficial position for the creditor);
(ii) for specific amounts – i.e. guaranteeing all the payment obligations in relation to a specific transaction only (better for the guarantor).
The effect of a personal guarantee
Exposure to an unlimited financial liability with all the consequences which naturally flow from that is a sobering prospect. If the company breaches the underlying agreement and a claim is made by the creditor, the director will be liable to pay the company’s debt. If he does not have sufficient assets (including the family home) to cover the debt, he may be made bankrupt. The impact on his credit rating and the difficulty of obtaining financial services, insurance, etc. in the future barely need to be expressed. In addition, an undischarged bankrupt4 may not act as company director without leave of the court.
Further, where several directors give a personal guarantee (or give a single guarantee jointly and severally, as in our client’s case) to the same creditor, the creditor does not have to pursue all of them but can claim the whole amount from one guarantor. The stakes for each individual may prove to be very high.
Is there any way out of it?
Some comfort may be found in the knowledge that the courts have traditionally been very protective of guarantors and many events will reduce or release a guarantor’s liability (unless, however, the guarantee provides otherwise). The courts have taken this approach following equitable principles. For example, if the creditor breaches the underlying agreement or (without the consent of the guarantor) alters the liability of the principal obligor under it by increasing the amount of credit or by granting more time for the principal to pay, the guarantor may be left in a worse position when the guarantee is eventually called.
This inequitable outcome provides the guarantor, at common law, with a defence to a claim under the guarantee. The effect of such protection could mean that the guarantee is released in full, reduced in part, extinguished or unenforceable.
However, not surprisingly, the creditor will actively seek to expressly exclude any such protections from the guarantee. In our client’s case, the “guarantee” wording concluded as follows: “including any financial obligations arising from any changes in credit limit made to the credit account granted by us from time to time”.
The creditor therefore sought to ensure that our client was still on the hook even if, without his specific knowledge, the underlying agreement was altered by increasing the credit limit.
Had the client signed in his personal capacity and was his attention sufficiently drawn to the offending clause?
As the signature boxes immediately underneath the “guarantee” wording (which constituted two lines of small print hidden within an A4-sized document) required the signatures of the directors, it could be argued that our client had not signed the guarantee in his personal capacity but in his capacity as director of the company only.
Consequently, the guarantee would not have been signed by the “party to be charged” and would not fulfil the requirements of the Statute of Frauds 1677.5 Further, could he rely on the so-called “red hand” rule of contract law, which provides that the more onerous or unreasonable a clause is, the greater the notice which must be given of it (e.g. by writing it in red ink on the front page with a red hand pointing to it, to be sufficiently noticeable)?6
The court’s assessment of the parties’ intentions for entering into a contract, however, is an objective one – i.e. “The question is what a reasonable person, circumstanced as the actual parties were, would have understood the parties to have meant by the use of specific language”.7
The court will therefore look to the parties’ expressed rather than actual intention. Therefore, if the contract expressly refers to a director in his personal capacity giving commitments on behalf of the company, and that director has put his signature directly underneath such an unambiguous statement, it may be difficult to show that the Statute of Frauds’ requirements had not been met. In a recent case on similar facts to our client’s experience, the Court of Appeal made the following remarks in respect of the contract in question:
“The contractual text is very short. The Director is directed to read it. If he does not read it, he takes a certain chance. That is what happened in this case if he did not read it. The wording is clear beyond peradventure.”8
The Court of Appeal further held in the same case that even where the wording appears in smaller print than the rest of the contract, a director is still bound by his signature. The “red hand” rule may be helpful in arguments where the unreasonable term is contained in a separate document (e.g. the creditor’s standard terms of business) but not where it is included in the document actually signed by the parties. Therefore, once you have put ink to paper (or the equivalent electronically), it is extremely difficult to back track from there.
Can you argue that the terms are unfair?
Despite its name, the Unfair Contract Terms Act 1977 (“UCTA”) does not apply to all unfair terms. It only controls clauses that limit business liability, directly or indirectly, and does not examine whether a contract is generally unfair. Certain clauses in guarantees, because they are exclusion clauses (e.g. prohibiting set-off), may be held subject to UCTA and as such to be enforceable only to the extent they satisfy the reasonableness test. Section 11 provides that a clause must be:
“a fair and reasonable one” in the light of the “circumstances which were, or ought reasonably to have been, known to… the parties when the contract was made”.
However, the courts have made clear that many standard form clauses in guarantees will not be regarded as unreasonable where the guarantor is an experienced business person.9 In any event, in our client’s case, UCTA would not apply as the “guarantee” wording was not attempting to limit liability and was therefore not an exclusion clause.
Could our client then argue that, as an individual, he was protected by the Unfair Terms in Consumer Contracts Regulations 1999 (the “Regulations”)? In Barclays Bank Plc v Kufner10 it was held that:
“The Regulations would apply to a bank guarantee where the guarantor and the principal debtor each entered into their respective contracts as natural persons and were not acting in the course of their trade or profession.”11
Under the Regulations, a contractual term:
“which has not been individually negotiated shall be regarded as unfair if, contrary to the requirement of good faith, it causes significant imbalance in the parties’ rights and obligations arising from the contract, to the detriment of the consumer.”12
The Regulations further provide that a:
“term shall always be regarded as not having been individually negotiated where it has been drafted in advance and the consumer has therefore not been able to influence the substance of the term.”13
However, the Regulations were held not to apply in the Kufner case as the underlying loan agreement was not a consumer agreement (as it had been executed by a company). It was further held, however, that even if it was irrelevant that the company was not acting as a consumer, the Regulations would still not apply as it was clear that the guarantor, despite being an individual, was acting in a business capacity.
Similar facts applied to our client. It was irrelevant that the “guarantee” wording had not been individually negotiated with him or that the agreement was given to him on a “take it or leave it basis” – the Regulations did not apply. Credit was being extended to his company and so the credit agreement was not a consumer contract; his guarantee (albeit a personal one) was given by him acting in the course of and for the benefit of his business.
It follows that it would not be right for businesses to gain the benefits and protections of consumer legislation effectively by the back door. No matter how unfair it seems then, it is a hard case to actually argue.
Is there any hope?
It is unlikely that a guarantee hidden in the small print will provide the guarantor with an explicit right to terminate the guarantee. The general rule, however, is that a continuing (all monies) guarantee of all the principal’s liabilities can be terminated by giving notice to the creditor. This is because the consideration given by the creditor can usually be divided into different instances over the life of the guarantee.
Therefore, if the credit agreement can be terminated by the creditor on notice and no new transactions entered into or further credit extended to the principal, the guarantor should be able to terminate the guarantee by giving notice. Note though that this will not affect any rights that have accrued before the notice is given – i.e. the guarantor will still be on the hook for existing liabilities but, thankfully, he will be free from all future ones.
So, it may be wise to dig out all of those supplier agreements that you may have signed over the years, dust them off and get out the magnifying glass. If you find that you have given any personal guarantees, pick up the phone or email the supplier to give them notice that you are revoking the guarantee.
When entering future contracts, always read the small print and if you are unsure of its implications, seek advice before you sign it. Just a few seemingly innocuous words can have far-reaching consequences.
Always try to avoid giving a personal guarantee but at the very least try to ensure that it relates only to specific amounts or transactions (rather than “all monies”) or, alternatively, negotiate an overall cap.
The reality of the situation, unfortunately, is that if you have signed a personal guarantee it is extremely difficult to free yourself completely from your obligations under it.
If a creditor has called on a personal guarantee he will vigorously reject any challenges to it and will usually have standard methods of doing so. However, it is also worth noting that creditors will make every effort to receive money prior to going to court, as in many cases (particularly with banks) they do not wish to give the courts the opportunity to strike down a personal guarantee and in so doing set a precedent which would potentially devastate large numbers of similar guarantees held by them.
This can work in favour of a well-informed guarantor who argues his case well, as the creditor may be more willing to settle for a lower sum. This is precisely the route our client chose to take.
- See, for example, Barclays Bank Ltd v O’Brien  1 AC 180 and Royal Bank of Scotland v Etridge (No 2)  2 AC 773 concerning the giving of guarantees and undue influence
- Section 4, The Statute of Frauds 1677
- Golden Ocean Group Ltd v Salgaocar Mining Industries OVT Ltd 
- An undischarged bankrupt is someone who is still going through the process of bankruptcy, which usually takes a year – i.e. usually the bankrupt is discharged on the first anniversary of the date the bankruptcy order was made
- “upon which such action shall be brought or some memorandum or note thereof shall be in writing and signed by the party to be charged therewith or some other person thereunto by him lawfully authorised”
- See Lord Denning’s statements in J Spurling Ltd v Bradshaw  2 All ER 121
- Lord Steyn, Sirius International Insurance Co v FAI General Insurance Ltd  1WLR 3251
- Stephen Barrett v Brandon Hire Ltd  EWCA Civ 164
- Barclays Bank plc v Alfons Kufner  EWHC 2319 (Comm)
-  EWHC 2319 (Comm)
- It was held that Bayerische Hypotheken- und Wechselbank AG v Dietzinger (C-45/96)  1 W.L.R. 1035 applied
- Section 5(1), The Unfair Terms in Consumer Contracts Regulations 1999 No. 2083
- Section 5(2), The Unfair Terms in Consumer Contracts Regulations 1999 No. 2083