Understanding Directors’ Personal Guarantees and Corporate Insolvency

In this Harrison Drury guest blog, Keith Tully, partner at Real Business Rescue, explains the role of Directors’ Personal Guarantees in the corporate insolvency process.

It is common for company directors to provide personal guarantees when obtaining business borrowing. Lenders often do not allow companies to borrow money without such guarantees, as their risk is significantly increased without them.

For directors, however, the resulting exposure to personal liability and potential bankruptcy should the business fail, is a serious issue that must not be overlooked. It places their personal wealth and assets at risk if called upon following corporate insolvency.

What is a personal guarantee?

By signing a personal guarantee, a company director agrees to accept liability for repaying a loan if their business is no longer able to meet the obligation. It is a safeguard for business lenders that they will not lose money should the borrowing company default.

This type of agreement can be beneficial for both sides, as businesses gain access to the vital funding that allows them to grow, and lenders lessen their risk. If the director is unable to repay when called upon to do so, the lender can take them to court, putting at risk the director’s home and personal assets.

Personal guarantees can be secured or unsecured. If the director has provided a secured guarantee, the lender may be able to sell the asset in question without even having to go to court.

Additional interest and other costs may be added by the lender on default, which also become the director’s responsibility if the guarantee is called upon following insolvency.

When are personal guarantees required?

Personal guarantees may be required in a variety of lending situations, including:

• Applications for standard bank loans
• Lease agreements for business premises
• Business mortgages
• Lease arrangements for asset-based lending

When a personal guarantee is called upon

If a business enters insolvency and is subsequently liquidated, the lender will call upon a personal guarantee provided by one of the company’s directors. This forces the director to fulfil their written agreement to repay the loan – a situation that probably seemed unlikely when the guarantee was signed, and the business was profitable.

Corporate insolvency does not necessarily mean the end for a business, however, and various solutions exist that could help the company survive. But in the worst case scenario, it is worth knowing that a director’s exposure to risk can be managed to some degree prior to signing the guarantee.

Mitigating the risk of a personal guarantee

It is crucial to obtain legal advice before signing a personal guarantee. This helps to protect directors against the threat of personal liability from the outset, and understand the risks in more detail.

Each element of the guarantee should be clear, so the director fully understands their potential liability. It is also beneficial for the director providing the guarantee if it is for a specific loan, rather than general future borrowing.

If this is not possible, the director should attempt to negotiate a cap on liability to reduce their risk. They may also want to consider taking out a personal guarantee insurance policy.

What is personal guarantee insurance?

This form of insurance offers some protection for directors from personal bankruptcy, by covering a proportion of the liability presented by the guarantee. Cover increases gradually over a period of time, usually up to around 90% of the liability by year five.

Personal guarantee insurance can help to prevent bankruptcy for directors faced with limited means to repay failed business lending. Although it will be seen as another expense by some, the cost of a policy depends on a variety of factors including the industry in which the company operates, and its previous history of repayments.

Written by Keith Tully; Partner at Real Business Rescue, part of Begbies Traynor Group. Keith has 25 years’ experience advising company directors and stakeholders on matters such as corporate insolvency, finance and restructuring.