If you are a director of a small company, it is likely that you have signed a personal guarantee, perhaps several. Whether or not directors’ personal guarantees are an inevitable cost of doing business for small companies with limited assets, the effects can be serious and are often misunderstood. So how much have you put on the line for your business, and what can you do to minimise your exposure?
What is a personal guarantee?
The most important feature of modern companies is the idea of limited liability. By establishing a legal entity that stands between you and your business activities, the buck stops with the company, preventing shareholders and directors from personally bearing the burden of any liabilities incurred by the business (subject to a number of statutory exceptions).
However, banks, landlords, financiers and other key business partners almost uniformly ask small companies with limited assets to ‘lift the corporate veil’ and have directors (and occasionally shareholders) promise to be personally liable if the company fails to pay its debts or perform its obligations. By signing a personal guarantee, you are therefore contractually putting your own assets on the line, including your personal finances, your material assets and even your family home.
What are some of the risks?
Personal guarantees can take a variety of forms, but are often more extensive than many directors may realise. In addition to the principal liability incurred by your company, the guarantee may also cover extra costs, such as interest rates, debt recovery fees and even creditors’ legal costs. Directors are often required to sign an ‘all moneys’ guarantee, rendering them personally liable for the entirety of the company’s debts and liabilities regardless of their origin and when they arise.
One of the most onerous features of personal guarantees—and one that can lead to nasty surprises for former company directors—is that they often (and typically will) extend beyond the life of your directorship. The guarantee is a contract signed in your own name, so there is nothing that inherently makes the liability under it dependent on your position within the company. Unless the terms of the guarantee itself specify otherwise, this means that your liability will extend beyond your resignation, and potentially even after the company stops trading or winds up.
Finally, many guarantees are given ‘jointly and severally’ by directors. This may not mean much to you, but these words can have serious implications. It means that a creditor may call on all directors to pay a company debt, but they could equally pursue any one director for the entirety of the debt.
What can you do?
While a personal guarantee can be often unavoidable for smaller businesses, it is not necessarily inevitable in all cases. Where your business is important to a particular creditor and you have enough negotiating power, you may be able to assure them with an alternative, such as a bank guarantee. In any case, you should always attempt to limit your liability as far as possible, including by limiting the term of the guarantee to the period of your directorship or to a particular amount.
If the other party still refuses to extend credit without a full and largely unlimited personal guarantee, then you must ensure that you keep on top of your obligations. Maintain a comprehensive register of any personal guarantees you have given so you don’t lose track. Once your time as director is up, then you need to take active steps to withdraw your guarantee or replace it with one form a new director. This can be complex and often requires approval or confirmation by the creditor, so it is important to get independent legal advice. Sometimes it may require ending an account and opening a new account.