A personal guarantee is an agreement by a third party individual (the “guarantor”) to satisfy the contractual obligations of another party, in the event that party fails to do so.
A lender may ask for a personal guarantee to be granted by the directors of a company to which it will advance a loan, particularly in the context of development finance. The personal guarantee will form part of the package of security to be granted to the lender, which the lender will want to ensure protects its position if the borrower defaults on the loan. The level of security granted by the borrower (or connected third parties) will depend on the size and nature of the loan but may also include a legal mortgage over specific real property, a charge over the assets of the borrower generally and/or a charge over the shares of the borrower (if a company).
Increasingly, lenders will require the guarantor to obtain ‘independent legal advice’ (or, “ILA”) from a solicitor who is unconnected to the loan transaction. The solicitor will usually be required to provide the advice either on the telephone or in person and issue an ILA Letter confirming that the nature of the personal guarantee and the risks associated with granting it, have been explained to the guarantor and seek confirmation from the guarantor that such risks are understood. We have set out below some key points for prospective individual guarantors, to look out for:
1. Who is giving a guarantee and are the guarantors ‘jointly’ or ‘jointly and severally’ liable?
If more than one person is giving a personal guarantee in connection with a loan, then it is important to check the extent to which each of the guarantors is liable. Most often, the guarantors will be ‘jointly and severally liable’. This means that the lender can pursue any or all of the guarantors for the full amount. If, for example, there are two guarantors, they will both be liable for the full amount due under the guarantee (not 50 per cent each) and the lender can choose which guarantor to pursue, if not both. It will then be a matter for the guarantors to consider separately themselves, whether any money is owed between them.
2. Is there a cap on the amount that the lender can pursue the guarantor for and can further advances be made to the borrower?
One of the most important things for the guarantor to consider is how much the lender will be able to pursue them for. The extent of the guarantor’s liability under the guarantee will either be limited to a certain amount, or it will extend to the full balance owed by the borrower to the lender. The guarantor must be comfortable that he/she will be in a position to meet the full amount for which they are liable, for as long as the guarantee is in force. It is also important to consider whether any further loans can be made to the borrower under the loan agreement and whether these will also be caught by the guarantee (this will usually be the case where the guarantee extends to “all monies” owed by the borrower).
3. Is it a guarantee or an indemnity?
A simple guarantee creates a secondary liability on the guarantor to fulfil the primary obligations of the borrower, in the event the borrower fails to do so. This means that if the underlying obligations of the borrower fall away, so does the guarantor’s liability. In most guarantees however, the lender will include indemnity wording which also creates a primary obligation on the guarantor. This means that if, for any reason, the underlying agreement between the lender and borrower fails, the lender can still rely on its indemnity. The lender can also pursue the guarantor straight away, without needing to pursue the borrower first, in the event it defaults on its obligations under the loan.
4. Can the guarantor be pursued for costs?
Even when the guarantor’s liability under the guarantee is capped at a specific amount, the guarantor is also likely to be liable for any enforcement costs incurred by the lender in pursuing the debt. Interest is also likely to accrue on the outstanding amount. Such costs and interest will often be payable on top of the capped amount and often there will not be a limit to the amount of costs or interest which can be claimed by the lender. The full amount that could become payable under the guarantee, is therefore unlikely to be certain. It is for this reason that a guarantor must be sure that he/she can discharge the obligations if demand is made.
5. What representations and warranties will the guarantor give and can they be given?
The guarantor will give certain representations and warranties under the guarantee. These are statements which the guarantor confirms are true upon granting the guarantee and if they are found to be untrue, the lender can initiate legal proceedings against the guarantor for breach of contract. It is therefore important that the prospective guarantor reviews the representations and warranties to ensure these can be given. Any that cannot be given should be raised with the lender, and negotiated.
6. What of the guarantor’s assets are at risk?
If the guarantor is unable to discharge the borrower’s obligations on demand by the lender under the guarantee, the lender would then be in a position initiate court proceedings against the guarantor for breach of contract or, more likely, the lender could initiate bankruptcy proceedings against the guarantor. This will put the guarantor’s personal assets at risk and it is important for the guarantor to be aware that usually, all their assets are at risk including the family home, even if it is owned jointly with someone else.
The above sets out a brief summary as to some typical provisions found in personal guarantees, which the guarantor should be alive to. We would suggest that it is also worth keeping in mind that although the provision of a personal guarantee can sometimes feel like a secondary concern when arranging and negotiating loan facilities for the borrower (and therefore one which is often left to the last minute), it should be entered into with care and caution. Where ILA is required to be given, it is always advisable to instruct a lawyer to provide the necessary advice as early as possible, to avoid any undue delay to the wider loan transaction.