Structuring your business as a limited company reduces your personal liability and financial obligations regarding your business-related debts and contractual agreements.
However, a lender or supplier may insist that directors sign a personal guarantee as security for a company's borrowing. This personal guarantee empowers the lender to demand debt repayment legally.
In today's unprecedented economic times, you would be well advised to seek experienced legal advice if asked to sign a personal guarantee. No business owner can be complacent about becoming personally liable for business debt and any claim on personal assets.
Therefore, it’s important for individual directors to recognise the potential downsides to signing a personal guarantee.
If asked to sign one, you should question the following:
- Is the company financially viable?
- Is the company facing significant financial pressures with cash flow concerns?
In this article, we help you understand the laws around personal guarantees to ensure you have all the information available when considering if this is the right financial decision for you and your business.
What is a personal guarantee?
A personal guarantee is a legally binding contract between a lender and a third party. The third party agrees that if the borrower defaults on loan repayments, they’ll be responsible for paying the remaining debt.
For example, a parent can provide a personal guarantee over their child’s mortgage, meaning the bank can call on the parent to pay back the loan if their child fails to make mortgage payments.
Similarly, as a company is a separate legal entity, it can borrow funds in its own right. However, the lender may insist that the director/s of the company provide a personal guarantee in case the company becomes insolvent.
When is a personal guarantee required?
Personal guarantees from company directors will nearly always be required for:
- Bank overdrafts
- Commercial rent
- Trade credits
- Unsecured business loans
- Invoice finance
- Property loans
- Leasing agreements
The advantage of entering into a personal guarantee is that they can obtain financing for your company. If a business is experiencing cash flow problems, an injection of funds can make the difference between continuing to operate or closing.
Furthermore, personal liability can be capped, but it will be up to you to negotiate hard to ensure your liability doesn’t result in your personal financial situation being jeopardised.
How long is a personal guarantee enforceable?
If you provide a personal guarantee, your obligation lasts as long as stated in your agreement with the lender. This is important as although you may resign as a company director, your obligations under guarantee don’t necessarily end.
What happens if a guarantor dies?
The death of a guarantor doesn’t necessarily end their obligations under the guarantee. If the company defaults on its payments, the lender can look to the guarantor’s estate to recover the money owed.
Can I cap my liability under a personal guarantee?
The healthier your company's financial position is, the more leverage you’ll have in negotiating a cap on your liability under a personal guarantee for a company loan.
The most important factor in limiting your liability is to start negotiations as early as possible after you have received legal advice on which points of the agreement the lender may be willing to be flexible.
Can I get out of a personal guarantee?
Getting out of a personal guarantee is difficult if your limited company becomes insolvent.
You should seek advice as there may be flaws. Rather than admit liability, take advice on claims from a creditor as soon as possible. Time will be crucial in this situation.
Your choices regarding the personal guarantee are:
- Challenge the validity and enforceability
- Pay it in full
- Negotiate payment terms of the guarantee, either a reduced amount or a payment plan
- File for personal bankruptcy or enter an IVA
Of course, option four should only be taken as a last resort, and you should never contemplate this option after taking specialist advice from a qualified insolvency practitioner.
Although you may feel under extraordinary stress, there are options, and genuinely if there is no money to pay, a creditor will be realistic and likely negotiate payment terms. It is, however, important to how this is presented in the financial statements of any business.
Does a personal guarantee survive bankruptcy?
Bankruptcy will relieve you of your debts, including any personal guarantees you have made. Once the bankruptcy has ended, creditors cannot pursue you for any additional money.
However, if you provided security over your personal guarantee (for example, your home or other assets), the appointed trustee tasked with managing your bankruptcy can sell the asset to pay any secured creditors. This includes the lender to whom you provided the guarantee.
Get legal assistance from LawBite
In challenging economic times, business owners are naturally willing to try anything to keep the business alive; however, if you must provide a personal guarantee, ensure the contract is reviewed by a qualified solicitor.
You must understand the extent of the business liability and your obligation towards the company's financial position, so you can negotiate terms in your favour. To find out how LawBite can help you understand the terms of a personal guarantee, or review a personal guarantee that you’ve signed, book a free 15 minute consultation or call us on 020 3808 8314.