Written by Fiona Jewell, a solicitor in the Corporate and Commercial team at Thomson Snell & Passmore Solicitors.
December 17, 2013 : The implications for a guarantor can be far reaching and the specific terms of the personal guarantee should be considered carefully.
In the aftermath of the recession, the requirement for a personal guarantee from a director or shareholder has become standard practice whenever a small company looks to borrow money from a bank. Whilst personal guarantees may now be an unavoidable part of raising finance for small businesses, it is important for the people providing guarantees (the guarantors) to be aware of the implications and consequences involved.
A personal guarantee given to a bank will usually be held as security for all the debts owed to that bank by the company. This means that, under a personal guarantee, a bank could make the guarantor pay, on demand, all of the company’s debts which are due to the bank however and whenever they arise.
If the personal guarantee is called on, a bank has various options for recovering what is owed. It might take legal proceedings to get a court order against the guarantor and his or her assets. This might be a garnishee order (where the court orders that the company (or another employer) pays the guarantor’s earnings direct to the bank), or an order that assets are seized and sold and the proceeds put towards paying what is owed to the bank. The family home can be at risk and any other substantial personal assets.
A bank may agree to cap the guarantor’s liability under the personal guarantee to a fixed amount plus interest on that amount and any costs incurred in enforcing the bank’s rights. Before entering into a personal guarantee, placing a limit or cap on the guarantor’s liability should be discussed with the bank. It is worth bearing in mind during negotiations that, in reality, the total amount covered by a personal guarantee can be more than double the cap after interest and costs have been added.
Provisions in a personal guarantee typically provide that:
• The bank does not need to demand payment from the company first;
• The personal guarantee is separate from and not limited by any other mortgage or guarantee which may already have been given to the bank or which may be given in the future;
• The personal guarantee covers all types of current and future liabilities. This will include liability under overdrafts, loans and other facilities. It will also cover liabilities incurred by the company without the consent or knowledge of the guarantor;
• If a higher overdraft limit is granted or if the company borrows more money from the bank, then this additional amount will also be covered by the personal guarantee (up to the cap plus interest and costs); and
• Where there are two or more people giving the guarantee, the obligations are joint and several. This means that the bank may require either one or all of the guarantors to meet a demand. When a guarantor pays more than his or her share of a debt under a guarantee, there is an equitable right for contribution from the co-guarantors and from the company. However, in practical terms, this can be difficult to enforce and consent from the bank is normally required before a guarantor can enforce his or her equitable right of contribution.
Having given a personal guarantee, a guarantor is not typically able to cancel it in the event that the guarantor changes his or her mind at a later date. In addition, a personal guarantee remains in existence even if there is no amount outstanding at any particular point in time.
A personal guarantee will normally allow for termination on notice (often, three months) in respect of any new liabilities. However, the personal guarantee will remain binding in respect of any liabilities which have already been incurred by the company prior to the expiry of the notice to terminate. The only sure way to bring a guarantor’s liability under a personal guarantee to an end is to ask the bank to give a written release.
When leaving a company as a director or shareholder, where a personal guarantee has been given, it is essential for the exiting guarantor to serve notice to terminate his or her liabilities under the personal guarantee and to obtain a release from the bank. Too often this step is overlooked which can lead to the horror scenario where a person finds themselves personally liable for the debts of a company that he or she left many years ago.
Ideally, before granting a personal guarantee to a bank, independent legal advice should always be sought as the implications for a guarantor can be far reaching and the specific terms of the personal guarantee should be considered carefully.
Source: Director of Finance Online