Before a personal guarantee on a loan is signed, the bank will usually insist the director of the company seeks independent legal advice from a solicitor.
The directors of most SMEs will likely be asked to sign a personal guarantee by the bank that agrees to lend to it, but before you sign anything you need to be aware of a few things which we’ll discuss in this post.
What You Need to Know Before Signing a Personal Guarantee
When it comes to signing a personal guarantee, there are a few avenues to be cautious about. A personal guarantee is a director’s promise that if their company fails to do something, then the director will do it instead. Usually it is the company´s failure to pay money when it is due that brings the guarantee into operation.
What’s the Difference Between a Directors Guarantee vs Personal Guarantee?
There’s no explicit difference between a directors guarantee vs a personal guarantee. The two terms are interchangeable and are also known as a director’s personal guarantee, as directors of private limited companies are usually the personal guarantors on a loan. However, the roles and financial responsibility of those signing a personal guarantee remain the same.
Advantages of a Directors’ Personal Guarantee on a Loan
- A viable option for SME’s to get a loan
Whether your business is a start-up or a small-and-medium-sized enterprise, it can be quite challenging to borrow money, open a trading account with suppliers or to lease property. If you are a new start-up or one without a lot of capital, you will be more likely required to sign a personal guarantee. This gives banks, suppliers and landlords confidence to deal with you.
- Shows drive and vision
Signing a personal guarantee shows banks or other potential lenders that there is internal confidence that a SME will succeed.
- Gives your business security
Although the risks with signing a personal guarantee are high for the guarantor, it also gives other non-stakeholder directors the reassurance and security that any monetary problems will be taken care of if there is a financial issue, making them less likely to be concerned about liability for wrongful trading.
- Personal guarantee insurance
You can take our personal guarantee insurance, meaning that the collateral risk is reduced. Although premiums may be high, you can usually find personal guarantee insurance available up to 80% of the debt or loan that needs repaying.
Disadvantages of a Directors’ Personal Guarantee on a Loan
- Risk
A guarantee removes some of the advantages of having a limited company altogether. An important reason for trading through a limited liability company is to separate the director’s personal assets from those of the business. A personal guarantee pierces the corporate veil which would usually provide financial protection.
Personal assets are now at risk as the guarantee will usually be for ‘all monies’ due from the company to the lender. As such, it will cover new or increased borrowing since the personal guarantee was signed. It is therefore essential to make sure that the personal guarantee is cancelled once the original purpose for which it was given has come to an end, otherwise guarantors could find the guarantee coming back to haunt them long after they thought that the original money borrowed had been repaid or even after they have left the company.
- Reluctance
The directors may reluctantly agree to give a guarantee if there is no other way of the company getting the loan or supplies it needs. For example, it’s common for a supplier to ask for a guarantee before delivering goods or services. Although sometimes, the guarantee can work in favour of the company to be offered better terms on the basis that risk for the lender or supplier is reduced.
- Demand
The bank will normally be able to require payment ‘on demand.’ This can cause problems even for wealthy directors if their funds are tied up elsewhere and they don’t have the money to cover the debt.
- Financial burden
The obvious danger is that the director must pay up under the guarantee when the company is in difficulties. This will come at the worst possible time when the director’s income is under threat and business is struggling. Although the amount payable is usually limited to a certain amount, interest charges and enforcement costs can increase the financial burden.
- Bankruptcy
The worst-case scenario is that the director loses their home by signing a personal guarantee and is made bankrupt. What’s more, if there is more than one director, the liability will usually be joint and several. This means the bank can sue any of the directors for the full amount and doesn’t have to pursue each of them individually for their share of the total. Banks will typically go after the most wealthy and easiest target when enforcing a personal guarantee.
Seeking Legal Advice Before Signing a Personal Guarantee
The bank will normally insist that the directors take independent legal advice before signing a personal guarantee on a loan. This will reduce the possibility of the guarantor claiming undue influence or duress.
Seeking independent legal advice from a solicitor ensures directors know the extent of:
- What they are signing
- That they are not being pressurised to sign the personal guarantee
Companies Limited by Guarantee
A company limited by directors’ guarantee is a private limited company registered and regulated by Companies House. Instead of shareholders, the private limited company must have at least one personal guarantor, meaning that any loans or outstanding debts the personal responsibility of those guarantors to cover in a scenario of liquidation or where bills can’t be met. A company limited by directors’ guarantee may have many ‘members’ or ‘trustees’, all of whom are guarantors to oversee any changes made by the company. There is normally a nominal limit on the guarantee which can be as low as £1.
At Newtons Solicitors, we have our client’s interest at heart. Our company law specialists can offer legal advice to directors of limited companies; whether you are considering becoming a personal guarantor on a loan or are ready to sign a personal guarantee. Our team of experienced and knowledgeable solicitors can assist directors, guarantors, members or trustees with:
- Satisfying their bank’s requirements for independent advice
- Preparing guarantees if you are lending money or supplying goods
- Advice if you are unfortunate enough to receive a demand for payment under a personal guarantee on a loan
Please don’t hesitate to get in contact with our team of specialists. We will be more than happy to discuss your case if you have any queries or questions regarding the implications of a company limited by guarantee directors.