Personal Guarantees: What Are They And Can You Get Out Of One?
Money makes the world go round.
And personal guarantees are an important part of keeping the money flowing between lenders and businesses.
Indeed, in certain circumstances, they are vital for companies to gain investment.
A personal guarantee can be the difference between getting crucial business investment or not. But, they shouldn’t be taken lightly.
The implications of being unable to pay a personal guarantee are significant, and thus a proper understanding of what you are undertaking prior to making such a guarantee is vital.
This is even more critical if the business is facing financial difficulties, or is insolvent already.
In this blog we look to answer ‘What is a personal guarantee’, and whether it is possible to get out of one.
What is a personal guarantee?
A personal guarantee is a legally-binding commitment to repay a loan issued to a business.
In general, a personal guarantee will be made by a company director.
Should the business be unable to repay the loan, the responsibility to settle the debt will fall to the individual who has made the personal guarantee.
It is possible for multiple directors to give a personal guarantee to the same lender. This doesn’t reduce the individual liability, however, since the lender may opt to take action against one single guarantor should the loan not be repaid.
It’s worth noting that if you’re a sole trader rather than a limited company, you are personally responsible for all of your company’s debts.
Why are personal guarantees sometimes necessary?
Whether it’s a business loan, a property lease or an invoice finance agreement, there are a number of scenarios where personal guarantees are commonly seen.
But the focus of “why” such a guarantee is required generally comes down to the nature of the company requesting finance as opposed to the type or purpose of financing.
New, or small, businesses may have not yet built up sufficient credit history or credit rating to be able to receive external funding from creditors.
By providing a personal guarantee, a director adds their own credit history to the loan application – providing reassurance to the lender.
The lender will also look at the director’s assets – which will be liable to be liquidated in order to repay the debt should loan repayments fall through.
Personal guarantees and insolvency
A timely loan can be what steers a business away from insolvency.
Yet, backing a firm financially, when its balance sheet is looking less than healthy, is going to require some reassurance.
It is not uncommon in these types of situations for a director to step forward and provide a personal guarantee.
Should the business continue to slide into insolvency, however, they are liable to settle the debt.
Failure to do so can lead to court action, in which the lender may pursue the guarantor’s personal assets.
If the director is unable to pay, they may fall into bankruptcy, which can have serious implications for their involvement in business going forwards.
Read our blog for more information as to what is bankruptcy.
If you believe your financial situation may become perilous should you need to act on a personal guarantee.
It is well worth speaking to an insolvency practitioner at the earliest opportunity to ensure the situation is managed in order to cause the least financial and personal impact as possible.
Can you get out of a personal guarantee?
Following on from above, the question of whether you can get out of a personal guarantee is, unsurprisingly, a common one.
However, the answer is no.
Entering into a personal guarantee is to be tightly bound by a contract. No lender is going to enter into such an agreement without ensuring it is water-tight.
However, there are ways which can lessen the impact of having to settle a personal guarantee.
Firstly, not all personal guarantees are made equal. It may be preferable to opt, if acceptable to the lender, for a “limited” personal guarantee in which the director’s liability is capped. An unlimited guarantee would refer to 100% liability.
Another option for protection from personal guarantees is to take out personal guarantee insurance (PGI). PGI will cover some of the guarantor’s liability – normally up to 70%.
In some cases, it is possible to renegotiate the contract that underpins a personal guarantee. Of course, ideally, you want to agree upon acceptable terms prior to providing a personal guarantee. Note: any attempt to renegotiate the agreement must be done in advance of the company becoming insolvent.
There are also a range of personal debt solutions which might be appropriate in certain cases. These include declaring bankruptcy or entering into an individual voluntary arrangement (IVA) where a payment plan is produced (normally against a negotiated total debt).
At Hudson Weir, we look at each situation on a case-by-case basis and advise the most appropriate solution.
Are personal guarantees enforceable?
Personal guarantees are legally enforceable.
As mentioned above, personal guarantees are highly-scrutinised agreements.
There are several examples of guarantors going to the High Court in order to seek a way out of their personal guarantee, but to no avail.
It’s essential you don’t rush into a personal guarantee without fully understanding the extent of the potential repercussions should you become liable for your company’s debt.
Personal guarantees – final thoughts
In this article we have looked at personal guarantees, considering what they are and why they are used.
There’s no doubt that they can be an effective method to gain finance and drive a business to new heights – or turn it away from potential insolvency.
However, anyone who makes a personal guarantee should be well aware of the potential implication.
Being highly qualified Chartered Accountants and Chartered Insolvency Practitioners, the team at Hudson Weir are well placed to support you when it comes to managing personal guarantees.
Get in touch with our friendly team of experts today for more information.
