Bennett Griffin article 'Personal Guarantees for Directors – Voluntarily Piercing the Corporate Veil'
What Is A Personal Guarantee?
Many businesses will, at some point in their life, require finance, sometimes very quickly.
There are many reasons why financial support may be needed, including positive ones such as funding expansion or a strategic acquisition, and less positive ones, such as when the business is running out of funds and needs a capital injection.
Equally, there are many different sources of funding, from traditional High Street banks to specialist lenders operating in very specific market segments.
Funding often comes with conditions, and one we often see is that corporate borrowers (i.e. companies) need to provide personal guarantees as security to support borrowing.
In almost all cases, the guarantor will be one or more directors of the company.
But why are personal guarantees so common, and when will they be asked for?
Why Lenders Ask Directors For Personal Guarantees
Companies are often recommended as a vehicle for new businesses or for expanding sole traders or partnerships, due to their limited liability.
In most cases, an individual’s liability is limited to what they have invested in the business, with the legal principle of the Corporate Veil protecting individual directors and shareholders from personal liability for the company's debts and actions.
The principle of the Corporate Veil can generally be lifted or pierced only in limited circumstances by the Courts, and in many cases, there must be serious wrongdoing by the individual director before a finding of personal liability is made.
Furthermore, companies are treated as their own legal entities.
It is far easier for companies to simply disappear, through winding up or other insolvency routes, than it is for the people controlling those companies.
Hence, to mitigate the risk of being left with advanced funds to a company that no longer exists, lenders frequently demand personal guarantees.
Personal guarantees enable banks to avoid these risks by requiring the directors of companies borrowing funds to agree to being personally liable for their companies’ obligations to the bank, thus voluntarily circumventing the corporate veil.
When Are Personal Guarantees Most Likely To Be Required?
Typically, lenders are less likely to ask companies to provide personal guarantees when they can demonstrate a track record of healthy trading.
There is a greater likelihood, therefore, where, for example, a company seeking funding is newly or recently incorporated, or where funding is being sought in times of financial distress.
Should a personal guarantee be signed? Unfortunately, it is normally the case that the directors have little option but to agree to a personal guarantee if they wish the funding to progress.
There are, however, some key things which need to be considered, including:
Key Points To Check Before You Sign
“All monies” guarantees
· The personal guarantee is likely to be expressed as “all monies”, covering any liability which the company has to that particular lender at any time. It may therefore not just be guaranteeing the facility being obtained, for which the personal guarantee is required. With the more specialist lenders, this may not be a problem if the company has no other facilities, but with High Street lenders, there is a much greater chance of pre-existing or future facilities being personally guaranteed, even if at face value such facilities were not intended to be guaranteed.
Can the guarantee be capped?
· Ideally, the personal guarantee will be capped, and the cap may not necessarily be the full amount of the facility it supports. If a lower cap can be agreed, so much the better, although it must be remembered that this cap will only apply to the capital sum, and interest costs, etc., will usually be repayable on top of this.
Multiple guarantors, and who the lender can pursue
· If there are multiple personal guarantees, the bank will be under no obligation to share the risk. It will be at the bank's discretion to pursue whichever guarantor(s) are most likely to pay the sum due. Equally, the lender does not need to pursue the company itself first but can rely on the personal guarantee straightaway.
Guarantees usually aren’t time-limited
· Personal guarantees are generally not time-limited. Specific events such as insolvency, loss of capacity or even death will not end the guarantee, and in all cases, a negotiated exit will be required.
Getting written confirmation of release
· Linked to the above, personal guarantees are unlikely to lapse automatically when the facility is repaid in full. I always advise guarantors to expressly request a written confirmation of release upon repayment of the facility. Otherwise, it is possible for personal guarantors to lie dormant and potentially come back to life years later, for example, if another facility is taken out with the same lender and that facility ends up being guaranteed, even if that was not intended.
Why Independent Legal Advice Is Often Required
Personal guarantees, therefore, need to be treated carefully.
Indeed, following a series of cases in the 1990s where guarantors successfully claimed that they had no knowledge of the obligations they were being asked to guarantee or had been pressured into signing the guarantee by other parties, most guarantees will require a certificate to be completed by a lawyer confirming that the potential guarantor understands:
- · what they are signing
- · the consequences of entering the personal guarantee
- · and confirming that there are no signs of pressure or coercion or similar.
How We Can Help
Due to the risks associated with providing such advice, many solicitors do not offer this service.
Bennett Griffin however, can and does provide this service.
If you are a director or business owner in Worthing or the surrounding area and would like advice before signing a personal guarantee, our team would be pleased to assist.
Please contact either Nick Tompkin (nt@bennett-griffin.co.uk) or Lauren Baillie (lmb@bennett-griffin.co.uk) to discuss how we can help.
