Unsecured And Secured Loans: What If A Company Can’t Repay?
Secured loans or unsecured loans are crucial for many businesses, providing the investment they need to achieve their objectives and grow.
According to the British Business Bank, there was a 12.8% increase in gross bank lending to SMEs between 2021 and 2022. In total, banks provided £65.1bn in loans to small companies with more likely to have gone to larger businesses too!
But what’s the difference between secured loans and unsecured ones? Furthermore, how much liability is there for company directors in the event that the business struggles to repay a loan?
In this guide we’ll explain how secured and unsecured loans work, plus what happens if a company falls into debt or becomes insolvent.
What is a secured loan?
To reduce the lender’s risk exposure, a secured business loan provides them with collateral – a company asset.
Company assets could include anything from equipment and constructions to vehicles and intellectual property.
Therefore, secured loans tend to be for larger amounts. The loan repayment terms may be for a relatively longer period of time, potentially leading to more appealing repayment terms as well.
As we’ll explore later, the key risk for businesses with secured loans is what happens if they default on the repayments. This will put the secured company asset at risk.
What is an unsecured loan?
In contrast, an unsecured loan provided by a lender does not involve a company asset’s usage as collateral.
This can make the loan arrangement simpler and quicker to agree. The amount a business can borrow tends to be lower though, in comparison to a secured loan.
However, as an alternative to the security provided by a company asset, to reduce their risk, the lender may require a formal personal guarantee from a company director.
What is a director’s personal guarantee?
A personal guarantee is a legally-binding commitment to repay a business loan. Usually a company director, or several directors, will make this commitment.
It means that if the business is unable to make the repayments, the director becomes responsible for settling the debt.
As a signed contract, a personal guarantee is legally enforceable. However, if a director has agreed a ‘limited’ personal guarantee then their liability is capped.
Taking out personal guarantee insurance (PGI) also ensures that some of the director’s liability is covered.
What happens if my business cannot repay a loan?
Struggling to repay a business loan on time suggests there’s a problem requiring urgent attention. Hopefully you can resolve the situation swiftly and get back on track as soon as possible.
But if you haven’t already, it’s important to consider the three tests to check if the company is insolvent. If so, in the next section we’ll outline some of the options to address this.
Once a business is insolvent, directors’ duty must shift towards the company creditors – that includes any providers of unsecured or secured loans.
Ultimately, under the terms of secured loans, lenders can recover debt by taking ownership of the company asset or assets in question, then selling them.
If a company goes into administration or liquidation, the order of creditor repayment is as follows:
- Fixed charge secured creditors
- Preferential creditors
- Floating charge secured creditors
- Unsecured creditors
- Shareholders
And if needed, a director responsible for repaying a business’ unsecured loan debt – under the terms of a personal guarantee – can be pursued by lenders for personal assets in court.
Naturally, this could have significant implications for directors’ financial situation and in some cases, it leads to bankruptcy.
Before it comes to this, there are some proactive remedial solutions worth exploring.
Company debt solutions
If the company is going to struggle financially then we recommend contacting experienced insolvency practitioners such as Hudson Weir as soon as possible.
Depending on your circumstances, there are several potential options to consider including, but not limited to:
There are also arrangements available for directors who struggle with their liability for business debt, for example due to a personal guarantee.
Personal debt solutions, aside from declaring bankruptcy, include starting an individual voluntary arrangement (IVA).
Summary: Unsecured and secured loans – what if a company can’t repay?
Secured loans provide collateral in the form of a company asset, reducing risk for lenders to businesses.
Meanwhile, unsecured loans do not involve company assets but the lender may require a binding personal guarantee, usually from at least one company director.
In the event of insolvency, secured business assets and personal guarantees have a very important role during the repayment process for creditors.
Remember, if your business is experiencing a challenging financial situation and will struggle to repay a secured or unsecured loan, seek advice without delay, before things get worse.
You may also find our article on debentures helpful plus we’ve previously written about the key differences between floating and fixed charges.
For any specific queries about your business falling behind on loan repayments, or company debt and insolvency concerns, please don’t hesitate to get in touch.
