Secured loans v personal guarantees – some important differences and implications
It is very common for business loans, especially to fairly new businesses or small businesses, to involve some form of security or guarantee. Understandably, especially in the case of a personal guarantee, generally sought from a director in a business where the shareholders are also directors, this causes considerable worry and concern.
A common question asked by directors of small companies seeking business loans is whether a lender will only demand company security or a personal guarantee or perhaps both. The answer is it all depends on what security can be offered by the corporate entity and borrowers should seek to negotiate where possible and certainly get good legal advice.
It is worth noting that the main difference between taking security and a personal guarantee is that security generally relates to taking a charge over a specific asset (although a debenture or what is called a fixed and floating charge are also possible against company assets generally). A guarantee is not attached to anything as such, it is effectively a monetary promise.
Charge over director property?
It may also not be a choice for a lender between taking security over a company asset and requiring a personal guarantee. If directors own a property, a lender may also seek a charge over that property.
Things to look out for with personal guarantees
- Always try to limit a Personal Guarantee – from a borrower perspective the worst possible scenario is to agree an “all monies guarantee” which means guaranteeing all borrowing by the company. A personal guarantee may be required by a bank to support an overdraft or loan. The person giving the guarantee thinks that when then overdraft is cancelled or the loan is paid off, the guarantee necessarily falls away with it. This is incorrect. Later borrowings by the company would in theory continue to be guaranteed and that guarantee can be called in. Guarantees can be limited by time or overall amount, subject to negotiation. At the very least, if giving a personal guarantee which is not clearly limited, it’s important to check how you can cancel it, to make diary reminders to check and to seek to cancel it, if allowed under the personal guarantee document, at a time when the borrowing is ended or at zero.
- Joint and several liability – in many scenarios a lender to a corporate entity may require that more than 1 director gives a personal guarantee. In that situation, usually the guarantee will be drafted on a joint and several basis. This means both guarantors are jointly but also separately liable. In practical terms, there is no requirement for the lender, where there is default by the company, to go after both guarantors to the same extent or in fact to go after both at all. The lender can choose the easiest target and just pursue 1 of the guarantors for the liability. Consequently, where there are several guarantors on a joint and several basis, they are well advised to insist on cross guarantees or indemnities from each other, so that if only 1 guarantor ends up paying the full liability, he or she has a contractual right to pursue the other guarantors for their share.
- Primary or secondary obligation? – if the former, this imposes an obligation on the guarantor to meet any default by borrower under the contract. A secondary obligation instead imposes an obligation that the company pays for it’s borrowings. In practical terms, default under a primary guarantee entitles the lender to go after the guarantor for the default sum. With a secondary guarantee the lender must sue for breach of contract and importantly must demonstrate loss caused by the breach, including mitigation of loss. The amount recoverable here may well be different form 0the sum demanded and recoverable under a primary obligation.
- Regularise and protect your position with the company – personal guarantees are commonly sought from directors of the borrowing company but where a lender does not believe the director has assets, a suitable external person may have to agree to guarantee the borrowing. Typically, this will be a close relative of a director. Even if the guarantor is a director, things can and do change within companies. Unless the company is fully controlled by a single director and that person gives the guarantee, protection should be sought from the company. This can be an indemnity in favour of the guarantor but almost as important is a contractual right for a guarantor to be kept informed of the company’s financial position, the status of the loan supported by the guarantee i.e evidence of payments being and up to date, notice of any defaults, regular management or other accounts information and protection against changes in control of the business such as restriction of new directors being appointed, restriction on dividends until loans are paid off and so on.
For advice on corporate borrowing, unsecured or secured business loans, personal guarantees or legal advice on a dispute regarding any of these aspects, get in touch with Debbie Serota, who has considerable experience in this area of law.
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