Personal Guarantees in Commercial Lending

February 7, 2020

Owners of businesses operating as corporate entities will be familiar with the use of personal guarantees when taking out commercial loans. Anyone who has been asked to act as a guarantor will also know that lenders often require the individual to take independent legal advice on the matter. Which is separate from the advice being given to the company or partnership. This applies even if the guarantor is a director or partner of that business.

What is a personal guarantee?

It is a legal pledge made by an individual, to the lender, in respect of a loan or facility being taken by the corporate entity (e.g. a company or partnership). In exchange for the lender granting the loan, the individual pledges their personal assets as an assurance should the business default on its repayments. Or otherwise breach the terms of its loan agreement. Under most guarantees, the guarantor effectively acts as principal debtor. Which means that the lender views the guarantor as if they were a party to the original loan itself and thereby responsible for complying with its terms. This guarantee allows the lender to effectively seize control of the guarantors’ personal assets. Selling them off in order to pay back the loan should the business fail to meets its obligations. A personal guarantee is therefore a very powerful and useful document from a lenders’ perspective.

What about directors’ guarantees?

In law, incorporated businesses are viewed as separate legal entities/personalities. This means they are considered as being independent from the individuals that run and own the business itself. When a company applies for a loan, the company itself will be responsible for its own debt, not the directors or shareholders.

If a company falls into difficulty with making its repayments, or becomes insolvent, the lender may have a hard time in enforcing its terms against the company in an effort to recover its money. To limit this risk lenders will often ask the directors to guarantee the company’s debts. This will also apply to limited liability partnerships.

The directors’ personal assets (e.g. family home, properties, savings, cash) are effectively at risk should the company default on its loan agreement.

What should I watch out for?

Personal guarantees, whilst a common occurrence in commercial lending, are often viewed as an annoying addition to the process. As the guarantor may initially fail to understand its significance. However, specific legal advice should be given so that the guarantor fully understands its implications. Some rather onerous terms will often include:

A lack of power to negotiate or vary any terms of the loan agreement (e.g. repayment terms).
The guarantee may not be limited to simply the initial loan. It may be drafted in such as way as to include any loan or debt of the company, whether now or in the future, which you may or may not have knowledge of. These are called “all monies” guarantees.
If any of your personal assets are already subject to a charge by an existing lender, you will often be required to get consent from the separate lender before proceeding. A separate Deed of Priority will often be required. Which is a legal document that sets out which lender gets what first in the event that assets have to be seized to repay any loans.
Often there is a term in the loan agreement which means the lender can “call in” their loan on demand. The lender can effectively demand repayment at any time, which means if the company is unable to repay, it may look to the guarantor as a means of repayment.
If the loan is repaid early, costs and interest may be due which were not accounted for.

Personal liability where there is more than one guarantor

Personal guarantees will often state that, where there is more than one guarantor to the loan, each of those guarantors is “jointly and severally” liable. This means that the lender can effectively take action against both of the guarantors. Or, if it prefers, against one guarantor only.

This may arise if one of the guarantors is a better prospect for repayment than the others.

Security

Lenders will sometimes require a charge to be placed on specific assets pledged by the guarantor (e.g. family home or investment properties). In such cases, the bank will secure their interest in the property by registering a charge against the title. This will prevent the guarantor from disposing of the property without the consent of the lender.

If the property is already charged under an existing mortgage, you may be forced to seek the consent of your existing mortgage lender and further documentation will be required.

Furthermore, if the asset is co-owned with a third party (i.e. spouse or family member), the bank may ask the third-party to provide a separate guarantee, even though they may have no interest in the business.

Indemnities

Indemnities are often included as part of the guarantee and can place a greater liability on the guarantor. Typically, the sum guaranteed should not exceed the amount of the business loan. However, an indemnity clause creates a separate obligation owed by the guarantor to the lender. Which can sometimes apply after the loan has been repaid.

This would generally work as follows:

The company defaults on its obligations under the loan agreement;
The lender suffers a loss given the breach by the company;
The lender can rely on the indemnity given by the guarantor to pay back any losses.

For example, an indemnity clause can be utilised. This would extend liability to the guarantor where the lender needs to recoup its legal costs in pursuing any breach made by the company, through the courts or otherwise.

What we can do for you

We frequently provide independent legal advice on personal guarantees. Our service generally includes the following:

Reviewing and advising on the aspects of the personal guarantee. We will provide a written report to you setting out its general terms;
Face-to-face meeting to provide the advice in person, which will be required by the lender.
Witnessing your signature to the guarantee document and/or legal charge (if required);
Providing a solicitors’ certificate of advice to the borrower’s/company’s solicitor.

Hart Reade Solicitors are a full-service law firm with offices in Eastbourne, Hailsham, Polegate and Meads. We hold both Lexcel and Conveyancing Quality Accreditation from the Law Society of England and Wales. To make an appointment with one of our commercial property Solicitors, please phone our office on 01323 727 321.