Increasing numbers of UK directors are being faced with the request for personal guarantees. Many, optimistic about their business’ growth prospects, will sign on the dotted line. However, such blind optimism is often misplaced.
Here are top ten tips for personal guarantors.
1. Consider alternatives
Personal guarantees should be seen as a last resort. Limited liability should protect a company’s directors or shareholders. Personal guarantees “pierce this corporate veil” and mean that a guarantor’s own assets are on the line. Consider alternatives such as re-valuing freehold property to give the bank additional comfort.
2. Build in a review
A personal guarantee is far easier to grant than it is to negotiate away. Agree with your bank manager certain conditions as to when the personal guarantee could fall away, eg: after 12 months or on a certain turnover figure.
3. No charge
Make sure that you only agree to grant an unsecured personal guarantee. It is easier for the bank to proceed against the guarantor’s main asset, your home, if the bank holds a secured personal guarantee.
4. Cap it
Banks are increasingly arguing that the terms of their personal guarantees are “non-negotiable”. Often the personal guarantee has only one empty space to be completed, the limit on the director’s exposure. This limit should not necessarily equate to the bank’s overall exposure. It should reflect other security held.
5. A problem shared, is a problem halved
If other guarantors are prepared to step share the burden, follow-on negotiations should include whether liability is several (better for guarantors) or joint and several.
6. “What am I guaranteeing?”
A personal guarantee is often requested when new facilities are sought. If so, agree that the guarantee is limited to these additional facilities.
7. Prepare to be “Etridged”
Banks have lost many guarantee enforcement cases. Personal guarantors have often argued that they have not been properly advised. To counter this argument, there is now detailed guidance (Royal Bank of Scotland vs Etridge). This provides that each personal guarantor should get independent advice from their own solicitor.
8. “I have a cunning plan”
An often seen scenario is as follows:
- Director issues a personal guarantee to the bank.
- They then realise that the company is heading for insolvency.
- Director neglects payments to other creditors in order to pay down the bank’s facilities.
Unfortunately there is a flaw in this strategy, namely the Insolvency Act. A subsequently-appointed liquidator may be able to challenge additional payments to the bank as preferences.
9. Know your subrogation rights
The bank will often make a demand of the guarantor before looking to its other security. If the guarantor settles the bank’s entire debt, the guarantor may have the right (known as subrogation) to the benefit of the bank’s other security.
10. From personal guarantee to Enterprise Finance Guarantee scheme
Businesses with a turnover of up to £25m can apply through the Enterprise Finance Guarantee scheme for a bank loan of up to £1m (with the government guaranteeing 75 per cent of the loan). However certain conditions must be met. One of these is that other sources of security have been exhausted (if a director has granted a personal guarantee, an EFG loan may be a possibility).