Facing corporate insolvency: What do I need to know about personal guarantees?

Owners and directors of small and medium-sized businesses and start-ups are often required to sign personal guarantees in order to secure funding. 

Should you face corporate insolvency a personal guarantee can put all of your personal assets at risk, including your family home, so you should always take independent legal advice before signing one to ensure that you understand your liability and the extent of the risk involved.

Why you might be asked to sign a personal guarantee

Raising money to create or invest in your business can be difficult if it is a new venture without evidence of successful trading to show the bank or potential investors. In this situation, it is common for a personal guarantee to be requested, for example, when seeking investment, an overdraft facility, a property loan or trade credit.

The guarantee document is an agreement to take responsibility for a debt in the event that it is not repaid as agreed, by using personal assets to pay the debt and any other money accruing.

Mitigating the risk – capped liability and insurance

It is important to fully understand the extent of a personal guarantee agreement before signing it and, if possible, agree on a cap. This will limit the amount that can be claimed in the event of difficulties and means that you know exactly how much you stand to lose in a worst-case scenario.

There may also the option of taking out personal guarantee insurance, which could potentially allow you to avoid bankruptcy and the loss of your personal assets. 

Obtaining legal advice before signing

Because of the onerous nature of a personal guarantee, everyone who signs it should take independent advice first. A bank or building society will often require this to be done as part of the process of entering into the agreement. If you waive your right to take independent legal advice, you may not be able to rely on this to try and avoid the guarantee agreement.

The agreement itself should be as specific and detailed as possible, setting out exactly what is covered by the personal guarantee, any limit on liability and the agreed processes for repayment and calling-in of the monies owed. This will help avoid future disagreements and will also give you clarity as to what is likely to happen and what is expected from you and when. 

Did your spouse or partner sign the personal guarantee?

If your spouse or partner has signed as a personal guarantor without first taking legal advice, they should take legal advice if it seems likely that the guarantee will be enforced. If they are not personally involved in the business but may lose their assets, this should have been explained to them beforehand. If it was not, they may have a defence or be able to make a case to save their property.

What happens when a personal guarantee is called in

The process can vary, and you should ensure that the creditor adheres to any terms within the guarantee document when calling in the debt. The most usual route that a creditor will follow is either issuing a statutory demand or issuing a claim to the court for a judgment.

A statutory demand will give you 21 days in which to pay the outstanding amount or alternatively to reach an agreement with the creditor over repayment failing which you may be at risk of bankruptcy proceedings. 

If a creditor makes a successful claim to the court for a judgment, then they will be able to obtain a warrant of execution, allowing bailiffs to seize goods, or a charging order which will allow them to register a charge against your property.

Challenging a claim against a personal guarentee

If you are facing the possibility of a personal guarantee being called in, you should take legal advice as soon as possible. Even where the creditor is a bank or other financial institution, it may still be possible to make a successful challenge.

We can consider in detail at the terms of the guarantee, how it was signed and by whom and the advice that was given (if any) before signing. We will be able to advise as to whether there are any defences available to you and whether the liability can be reduced in any way. 

Challenging a claim can involve complex issues of law, including equitable principles and unfair terms. The creditor is also required to go through a set process in enforcing the guarantee and if they do not carry this out correctly you may be able to challenge them. 

If your business runs into difficulties, you should start to look at your options as soon as you can rather than leaving the situation to grow worse. If you are unable to repay a debt that is due, you may be able to negotiate with your creditors. They may be willing to work out a payment plan with you to avoid enforcing the guarantee through the courts, which could be expensive and time-consuming for them and might not in any event mean that they recover all of the debt.

Be aware of the order in which you pay off the money you owe to your creditors if your company becomes insolvent. If you pay a personal guarantor ahead of other creditors, you may be in breach of the Insolvency Act 1986. This sets out a strict order in which creditors should be paid, and sets out restrictions on amongst other things, preferring one creditor over another.

Because of the complicated nature of challenging a personal guarantee agreement and the high stakes involved, it is advisable to seek professional advice on the best approach.

Summary

As many businesses face disruption in the current global turmoil, financial difficulties will arise for both borrowers and creditors. It is likely that personal guarantee agreements may be called upon as the economy struggles.

It is essential to address problems as soon as they arise, working out a long-term plan to deal with and overcome them. Creditors will be reassured to see that you are facing the situation and that you have a well thought out approach to difficulties.

If you are facing corporate insolvency, then by working with your creditors, you may be able to find a solution that means you can avoid losing personal assets, such as your home. It is often in everyone’s interests to save a business, so you may find that your creditors are willing to negotiate. But if you avoid the situation, they may feel that their only option is legal action.

We can talk through your options with you and help you formulate a plan for the future. 

At Lincoln & Rowe we understand the importance of helping our clients keep their businesses running smoothly. We have wide-ranging experience in commercial disputes and were named as the ‘Best Firm for Commercial Disputes in London’ in the 2019 SME Legal Awards as well as ‘Boutique Litigation Law Firm of the Year’ in the 2019 Global Awards by ACQ5.

If you would like to talk to one of our expert legal team about any queries you may have regarding personal guarantees, corporate insolvency or any other matter, contact the author, Dipesh Dosani, or call the team today on 020 3968 6030 and we’ll be happy to help.

The above information is for general guidance on your rights and responsibilities and is not legal advice. If you need more details on your rights or legal advice about what action to take, please contact a legal advisor.