The prospect of signing a legal document that provides a guarantee of someone else’s financial or other obligations, whether as part of a loan agreement or a lease, can potentially be very daunting, especially when considering the risks to your own financial position and your personal assets.
It is therefore important that you consider the financial standing of the person or company you are guaranteeing in terms of risk, as it is the risk that is the driver behind the bank’s or landlord’s requirements for a personal guarantee in the first place.
1. When is a personal guarantee likely to be needed?
This will depend on the financial standing or credit rating of the principal party in the eyes of the lender/landlord. Due to the limited liability nature of companies or LLPs, directors or members will often be required to offer personal guarantees until the company builds up its own financial standing and credit rating.
Personal guarantees may also be required for lease obligations, other contractual obligations, or for financial obligations to a lender including overdrafts or mortgages.
A personal guarantee is only worth what the guarantor is worth, so a guarantor may also be also asked to grant a security against the Guarantor’s personal assets, to back up the written personal guarantee.
Consideration should always be given to possible alternatives, such as a rent deposit in case of a lease, or an insured backed performance bond in the event of contractual obligations, if these options are available. A parent company guarantor might be an option for a company that is part of a wider group.
2. More than one personal guarantor? - Joint and several liability.
This is where a personal guarantee is provided by several individuals and it means that the person to whom the guarantee is owed can make claims against all or any of the guarantors for all or some of the money due. For example, if one of the guarantors is unable to pay when a sum becomes due, then the creditor has the right to pursue the remaining guarantor(s) separately or jointly for the whole of any unpaid amounts of the guarantee.
3. Bank standard terms and legal advice.
A personal guarantee for a loan is usually prepared on the standard terms set by the relevant lender and the scope for negotiation of the terms may be very limited.
Before entering into the personal guarantee, a lender will usually require that each guarantor obtains independent legal advice. This is to ensure that the guarantor has a clear understanding of the nature, consequences and extent of liability and risks associated with the personal guarantee. The independent solicitor must provide written confirmation, after a face-to-face meeting, that the guarantor understood what they were signing, were freely entering into the personal guarantee, and were not being placed under any undue influence.
A separate fee for this advice will be payable.
4. What is a guarantor’s maximum liability?
Depending on the commercial circumstances, a personal guarantee can be unlimited or limited.
Where possible, it is advisable to try to ensure that a personal guarantee includes a cap or limit on liability. This is less common in leases but may be negotiable where loans are being guaranteed. This is likely to be based on the level of debt owed by the borrower but is a matter for negotiation taking into account all relevant circumstances. However it is important to note that interest, expenses, default interest and other amounts that may be required to be paid under the personal guarantee s are not usually included in the capped limit.
5. How does a guarantor terminate the personal guarantee?
In the case of guarantees for loans it is usual for the creditor/bank to provide the guarantor with information setting out the conditions and procedure for cancellation by the guarantor at a future date.
This will sometimes include a condition stating that the guarantor may discontinue or fix their future liability by giving written notice to the relevant creditor/bank. The guarantor will remain liable for amounts due by the borrower incurred up to the end of the stated notice period.
Once a debt has been repaid or discharged, the guarantor is entitled to ask the creditor/bank to release them from the guarantee and to discharge any security granted to back it up. Even if in the case of a release clause, the creditor/bank may have continuing rights against the guarantor, for example in the event of a clawback of a payment.
Guarantees under leases will normally run for the duration of the lessee’s obligations under the lease.
6. What triggers a call on the guarantee?
A default of the principal party’s obligations will normally trigger the guarantee, for example, if rent payments or loan repayments are missed or a failure to comply with the conditions of a contract or lease, for example, not carrying out contractual works. The creditor is not obliged to sue the principal party first, and is entitled to seek payment from the guarantor of all sums guaranteed that have become due.
7. What happens if the guarantor cannot make payment?
This may lead to the creditor calling up any security granted by the guarantor or ultimately applying to the court for bankruptcy of the guarantor, on the basis that he or she is unable to pay the guaranteed sums owed to the creditor.
Sometimes giving a personal guarantee is unavoidable, especially for small businesses, but if you do give one, please make sure you understand the potential consequences, and be aware that former directors of companies that have given personal guarantees are not automatically released from previous guarantees once they cease being a director. In the majority of cases in this scenario a formal release will need to be negotiated, which may mean you have to find a suitable substitute personal guarantor.
For further advice, please feel free to contact cbarritt@prettys.co.uk.