When securing funding for their business, company directors are often required to give personal guarantees as security. This means the director becomes personally liable for the debt if the business defaults on its repayments.
As personal guarantee agreements are typically drafted to protect the lender’s interests, it’s crucial for directors to carefully assess the risks and seek expert legal advice before signing. Here, we outline the key elements of a personal guarantee and the potential risks involved.
What are Personal Guarantees?
A personal guarantee is a promise from the director to the lender that if the business cannot repay its loan, the director will cover the debt personally.
For lenders, this provides extra assurance they’ll recover their money. For directors, particularly those confident in their business’s success, a personal guarantee might feel like a small risk and balancing that against the challenge of accessing unsecured business loans may be one worth taking, particularly as agreeing to a personal guarantee can sometimes unlock vital funding.
That said, nothing in business is guaranteed, and we have noticed the rise in personal guarantees being enforced by lenders over the past 18 months. Directors need to be mindful of what external influences may affect the success of a business and must take precautions to avoid unnecessary personal risk.
Key Considerations When Signing a Personal Guarantee
Personal guarantees are legally binding contracts and become enforceable once signed. The terms can vary, but here are some important factors to consider:
- Personal assets at risk: If the company defaults, the director’s personal assets, including their home, may be sold by the lender without the need for court approval. A further consideration specifically regarding using your home as security, is the people who live in the property with you and any interest they may hold in it.
- Immediate repayment demands: Creditors may demand repayment at their discretion, often without notice.
- Indemnities: Some guarantees include indemnities, meaning the director could be liable for additional losses suffered by the lender—this should be avoided if possible.
- Ongoing liability: Guarantees might extend to future debts and accrued interest. Review the terms carefully to avoid unexpected obligations.
- Bankruptcy risk: Inability to meet the guarantee could lead to personal bankruptcy and disqualification from future directorships.
- Credit rating impact: Falling behind on repayments can damage your personal credit score, even if bankruptcy is avoided.
Questions to Ask Before Signing
Before agreeing to a personal guarantee, directors should reflect on the following:
- What constitutes a default under the agreement?
- How will the lender enforce the guarantee?
- Are there remedy periods for addressing payment shortfalls?
- Are there provisions to ensure the lender only pursues the guarantee as a last resort?
- Could your personal finances or assets change significantly after signing?
- Is there a cap on liability, and can it be negotiated?
If the business can provide security for the loan, a personal guarantee may not be necessary. Negotiating such terms early can protect directors from undue risk.
Expert Advice Is Essential
Signing a personal guarantee can be a vital step to secure funding and grow your business. However, directors should always proceed with caution. Consulting a legal expert ensures you fully understand the implications and can negotiate terms that protect your interests.
How can Nelsons help
Craig Bennett is an Senior Associate in our expert Dispute Resolution and Insolvency team.
If you have any queries about the subjects discussed above, please do not hesitate to contact Craig or another member of the team in Derby, Leicester, or Nottingham on 0800 024 1976 or via our online enquiry form.
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