As an individual, the prospect of signing a legal document which potentially risks your own personal assets can be daunting. Here are six key things to consider before entering into a personal guarantee:
1 When is a personal guarantee entered into, and by whom?
When lending to a rural business, a creditor/bank will typically ask for a personal guarantee where an owner-managed company or a partnership is looking to obtain business finance. This might be a business loan or overdraft facility, invoice financing, or funding for a property purchase or lease.
It is common for individuals behind the trading business, such as a director, shareholder or partner, or even a spouse of a director, shareholder or partner, to hold title to the assets used by the company or partnership. These assets could be machinery, farmland or even the family home.
For this reason, often the borrower (the trading business) is a different legal entity to the guarantor – as the bank/creditor tends to look to the holder of the assets behind the trading business to personally guarantee any funding provided. The guarantor may also be asked to grant a security against those assets, to back the personal guarantee.
2 Joint and several liability
A personal guarantee can be provided by one individual or several individuals.
Where there are multiple guarantors, each guarantor may be made “jointly and severally” liable to the creditor/bank under the personal guarantee. This enables the creditor/bank to make a partial claim or full claim against any of the guarantors for sums due by the borrower under the personal guarantee. This means that, if there are two guarantors and one is unable to pay, the creditor/bank can pursue the other for the whole amount guaranteed.
3 Bank standard terms and legal advice
The personal guarantee is usually prepared on the standard terms set by the relevant creditor/bank, so be aware that the scope for negotiation of the terms may be limited.
Before entering into the personal guarantee, the creditor/bank will usually require each guarantor to obtain independent legal advice. This is to ensure that the guarantor has a clear understanding of the nature, consequences and extent of liability and risks associated with the personal guarantee. The independent solicitor must provide written confirmation, after a face-to-face meeting, that the guarantor understood what they were signing, were freely entering into the personal guarantee and were not being placed under any undue influence.
4 What is a guarantor’s liability?
Depending on the commercial circumstances, a personal guarantee can be unlimited or limited.
It is usual for personal guarantees to have a cap on liability known as a limit. The limit is an agreed maximum amount which the guarantor can be required to pay if the creditor/bank enforces the personal guarantee. This is likely to be based on the level of debt of the borrower but is a matter for commercial negotiation taking into account all relevant circumstances (e.g. type and term of borrowing, availability of other forms of security and risk to the creditor/bank of the loans being made available to the borrower).
Interest, expenses, default interest and other amounts that may be required to be paid under the personal guarantee such as foreign currency exchange costs are not usually included in the capped limit (and so these will be payable over and above the limit).
5 How does a guarantor terminate the personal guarantee?
Before entering into a personal guarantee, it is usual for the creditor/bank to provide the guarantor with information setting out the procedure for cancellation by the guarantor at a future date.
There will also usually be a condition stating that the guarantor may discontinue or fix their future liability by giving written notice to the relevant creditor/bank. The guarantor will remain liable for amounts due by the borrower incurred up to the end of the stated notice period.
Any discontinuation or termination of the personal guarantee will have an impact on the borrower, with the creditor/bank likely to require alternative guarantees or security to be provided.
If the debt has been repaid or discharged, the guarantor is entitled to ask the creditor/bank to release them from the guarantee and to discharge any security granted to back it up. Notwithstanding a release, the creditor/bank may have continuing rights against the guarantor, for example in the event of a clawback of a payment.
6 When will the creditor/bank enforce the personal guarantee and what does this mean for the guarantor?
If the borrower defaults, for example, by missing a repayment or failing otherwise to comply with the conditions of the loan, the creditor/bank will review whether it is able in the circumstances to continue to support that borrower. If the creditor/bank is not able to do so, then it must look to the security and/or guarantees to recover the sums.
In addition or instead of seeking repayment via its rights under any security that the creditor/bank holds from the borrower, the creditor/bank is entitled to seek payment from the guarantor of all sums guaranteed – and now due – under the personal guarantee.
If the guarantor cannot make payment of the sums due under the personal guarantee this may lead to the creditor/bank calling up any security granted by the guarantor or ultimately applying to the court for the sequestration (bankruptcy) of the guarantor on the basis that he or she is unable to pay his or her debts – i.e. liabilities under the personal guarantee.