Commercial banks and other lenders risk their capital when they provide loans to businesses, so it is not uncommon for them to seek to protect their investment with a legally binding guarantee.
For many start-up businesses, a personal guarantee provided by a business owner, partner or director may be the only way to secure funding, and it can also provide access to higher loan amounts.
However, taking out a personal guarantee is not a decision to taken lightly, as you will be personally liable for the business’s debts if it fails.
What is a personal guarantee?
A personal guarantee is an assurance from a business owner, partner or other executive that they will become personally responsible for a business loan should the business default on the repayments.
Personal guarantees are particularly common in small business lending, where the business itself may not have the assets or track record to secure a loan independently.
The main purpose of a personal guarantee is to protect a lender’s position by providing them with security should the company be unable to meet its bills.
A personal guarantee can also influence the terms of the loan, such as more favourable interest rates or repayment schedules. It reflects a vote of confidence in your reliability and the viability of your business venture.
When a business has multiple owners, the guarantee is usually given “jointly and severally,” meaning a lender can choose who to pursue for the debt.
A guarantor who pays has a right of contribution from the others, but if the other parties were to disappear or be unable to pay, one individual could find themselves personally liable for the entire debt.
In practice, it is usual for a personal guarantee to be limited, which allows the lender to recover only a certain percentage of the loan from a given individual. However, the interest and expenses will be payable in additional to the amount secured through the guarantee.
An unlimited guarantee means the lender can recover the entire loan amount, plus interest and legal fees, by whatever means possible, if the borrowing business defaults on its loan, or even other loans that may be obtained by the same borrower.
The lender could take money from a director or guarantor’s personal assets, such as savings or properties – a substantial risk for the borrower.
In many cases, the use of a personal guarantee allows businesses to start up or expand successfully, and the guarantee is never called upon.
However, the potential pitfalls should still be considered before you agree to a personal guarantee.
When do I have to repay the loan?
You become liable under a personal guarantee when your business defaults on or becomes unable to repay a business loan and the lender makes demand.
If the borrower fails to make scheduled repayments or breaches other terms of the loan agreement, it’s likely that the lender will seek to enforce the guarantees and you’ll then become liable to pay the debt.
In cases where the primary borrower is a business that becomes insolvent and is unable to pay its debts, you’ll need to step in and meet your obligations under the loan agreement.
Additionally, certain loan agreements might specify situations under which your liability is triggered, beyond simply defaulting or becoming insolvent.
If you are not able to pay up immediately, the lender will normally look to discuss a payment plan rather than seeking bankruptcy, in order to maximise the amount they will receive.
Lenders are increasingly seeking charging orders against individuals’ homes, as this makes them a secured creditor, thus improving their position were the person concerned to go bankrupt.
It’s important that you understand fully the terms of your loan agreement and that you ensure the circumstances under which you will have to repay the loan yourself are outlined clearly.
Protecting yourself
It is often a lender requirement that you obtain independent legal advice from a solicitor before providing a personal guarantee, as this ensures you fully understand the legal risks.
For example, a personal guarantee can put your home at risk of being repossessed in the event that your business suffers financial problems and defaults on the repayments, other personal assets could also be at risk.
Therefore, it is more important than ever to seek independent legal advice from a personal guarantee solicitor to ensure you understand the risks and the circumstances under which you can be pursued for the value of the loan.
Personal guarantees with Palmers Solicitors
Our Company Commercial and Banking and Finance teams work together to provide essential business loan and startup funding legal advice, with fixed-fee arrangements to give you certainty and peace of mind.
We offer quick, clear guidance for personal guarantees, helping you understand your rights and obligations before entering into an agreement.
If you have already entered into an arrangement with a lender and your business is experiencing difficulties in meeting the repayment terms, we can check whether the guarantee has been correctly set up or whether there are grounds to dispute its validity.
We can also liaise with your lender to arrange a mutually acceptable repayment schedule which will allow your business to remain viable and also protect your residential property.
Get in touch with our company commercial team to find out how we can help you with directors’ personal guarantees. If you’re struggling with loan repayment liabilities, get in touch with our Banking and Finance team urgently.
