Granting a personal guarantee for company obligations can seem innocuous when securing initial credit or funding for a business operation, however the effects of calling up a personal guarantee can be far reaching. Starting up a business is an exciting time, and it is possible to be over-optimistic about a company’s prospects or cash flow, and to underestimate the collective value of a number of personal guarantees given. Trade accounts often approach lending with an expectation that personal guarantees will be granted for owner-managed companies. The potential effect of a personal guarantee should be considered carefully prior to signature. A personal guarantee will put a director’s personal assets at risk if called upon.
This blog considers personal guarantees which are commonly provided to obtain trade credit from the guarantor’s point of view.
What is a personal guarantee?
A personal guarantee is a document that, when signed by the guarantor, guarantees that if the obligations of the company (payment) are not met, they will be met by the guarantor. They are commonly used to personally guarantee trade accounts and they are also commonly requested by banks when lending to SME’s.
Put shortly, if a company under a contract fails to pay which has been personally guaranteed, the supplier can pursue the guarantor for the debt as if they were the original debtor.
Personal guarantees are not required when a partnership or sole trader takes on debt, as the individual is personally liable for the debts of the trading entity already.
How do personal guarantees work?
A personal guarantee is typically drafted as “all sums due” but can also be capped at a certain level. An “all sums due” guarantee puts the guarantor’s assets at risk for liability for the full debt sought in terms of the original contract. A capped personal guarantee puts the guarantor’s assets at risk to the level of the cap (i.e up to £50,000).
In the event that the personal guarantee is enforced against the guarantor, the guarantor’s personal assets (property, moveables and cash) are at risk if they are unable to pay. This includes the guarantor’s family home.
What if the company who has taken the credit goes into an insolvency process?
In the event that the original debtor is placed in an insolvency process, the guarantor remains liable in terms of the personal guarantee for the debts of the debtor. Whilst the creditor will have a claim in terms of the insolvency process for the debt, they do not need to pursue that claim if they prefer to pursue the personal guarantee. In general terms, the recovery to creditors from insolvency processes is very poor. Where a personal guarantee exists the creditor is more than likely to pursue recovery in terms of the personal guarantee and they do not require to wait for the insolvency process to be completed.
When can I challenge a personal guarantee?
The ability to challenge a personal guarantee is very limited. Generally, if the guarantee has been signed by the personal guarantor and it is clear on the face of the document that the document or clause constituted a personal guarantee, the challenge to a personal guarantee is limited to challenges to the validity of the contract. Such as misrepresentation; error or force and fear/undue influence when entering into the contract.
A personal guarantee can prescribe however, so that it is no longer enforceable. If the creditor has not taken any steps to enforce the guarantee within 5 years of it becoming enforceable, the guarantor’s obligation to pay will have prescribed.
Finally, in Scotland, a promise is enforceable, and if the creditor of the personal guarantee made a promise to you that the personal guarantee would not be called upon (eg until something was done such as a project was completed) then that would be a defence to payment in terms of the personal guarantee being due. For a promise to be enforceable, it must be clearly stated verbally or in writing and clear words used, generally “I promise”.
Can I negotiate a personal guarantee in practice?
Absolutely. Personal guarantees should not be provided as a matter of course. A creditor should be challenged as to whether and why a personal guarantee is required. In particular when opening trade accounts, the need for a personal guarantee should be questioned. Often the account can be opened without it.
If a personal guarantee is required, the guarantor should be clear on the amount that is being guaranteed and agree a cap. In particular taking care not to agree a form of words whereby the cap on the guarantee automatically increases when additional credit is given.
Importantly for trade accounts which have a personal guarantee, the method of ordering on that trade account should be clearly controlled within the debtor organisation so that the guarantor is not exposed to unknown debt.
For small businesses it can be a useful exercise to take stock of how many personal guarantees have been granted, and the value of those guarantees. If they are enforced, the value can be sought against the guarantor’s personal assets which can lead to wide ranging consequences for an individual on a failure of a business.
Anne Miller is a Legal Director in our Dispute Resolution and Claims Department dealing with commercial disputes, professional negligence and insolvency. For more information contact Anne on 01382 229111 or email amiller@thorntons-law.co.uk
