By Paul Taylor, Partner At Fox Williams LLP
You are a director of a growing UK business. Trading is good and you are keen to expand. You have just met with your bank manager who has agreed to extend your company’s banking facilities. However, there is a catch. You must agree to issue a personal guarantee ("PG").
Increasing numbers of UK directors are being faced with such a request. Many, optimistic about their business’ growth prospects, will "sign, seal and deliver" on the dotted line. However, such blind optimism is often misplaced. If the loans are not ultimately repaid, the bank will look to its security. It is often easier to pursue an individual, who has granted a PG, than enforce its security against the company.
Here are our top ten legal tips for directors faced with such a request.
1. Consider alternatives
PGs should be seen as a last resort. The clue is in the name of your company ABC Trading LIMITED. Limited liability should prevent a creditor from proceeding against a company’s directors or shareholders. PGs "pierce this corporate veil" and mean that a guarantor's house, car and other assets, are all on the line. "Quite right too", the bank will respond. Why should we show faith and lend to a business, if directors won’t show similar commitment?
However a director would be well advised to consider other alternatives to a PG. Consider re-valuing any freehold property to see if that will give the bank additional comfort; offer specific charges over key assets; look to assign to the bank life/key-man insurance policies etc.
2. Build in a review
You have lost the argument in 1 above and reluctantly agree to issue a PG. Be aware that a PG is far easier to grant, than it is to negotiate away. As a pre-condition, agree with your bank manager certain conditions as to when the PG could fall away e.g. after twelve months; when the company has paid off a particular facility or hits a certain turnover figure.
3. No charge
Make sure that you only agree to grant an unsecured PG. Banks will often request that a PG is secured by being backed up with a charge over the guarantor's house. Any spouse/cohabitee, will also be asked to grant security. Following any future default on the loan, it is easier for the bank to recover against the guarantor's main asset — their home. It also means that if a company fails, the director may not only lose his job but the roof over his head.
4. Cap it
Increasingly banks are arguing that the terms of their PGs are "non-negotiable".
A bank guarantee will typically run to four or five pages, the vast majority of the provisions are there to protect the bank. Often the guarantee has only one empty space to be completed, the limit on the director's exposure. This limit should not necessarily equate to the bank’s overall exposure. It will usually hold other security, such as a debenture over all the company’s assets. The PG should be capped accordingly.
5. Several not joint and several
"problem shared, is a problem halved" is certainly true of PGs. Why should one director take sole responsibility if other officers or shareholders benefit if the company is successful?
If other guarantors are prepared to step up to the mark, follow on negotiation should focus on whether their liability is several or joint and several.
A practical example: Director 1 and 2 sign a joint and several guarantee for £200k. On a default, the bank can demand from either director 1 (or director 2) the full £200k. Director 1 would then have to pay the full £200k and claim, taking the resultant credit risk, a £100k contribution from director 2. In the above example, if several liability had been negotiated at the outset, Director 1's maximum exposure would have been £100k.
6. "What am I guaranteeing?"
A PG is often requested when new facilities are sought. If so, agree that the guarantee is limited to these additional facilities.
As their default setting, banks will ask for an "all monies" guarantee which will cover all the company’s financial exposure to the bank.
7. Prepare to be "Etridged"
Over the years, banks have lost many guarantee enforcement cases. Courts have been sympathetic to the plight of directors and particularly their spouses.
One of the main successful ways of attacking a guarantee, is for the guarantor to argue that he has not been properly advised. To counter this argument, there is now detailed guidance (principally from the case of Royal Bank of Scotland -v- Etridge). This provides that each guarantor should get independent advice from their own solicitor.
Following proper procedures, the solicitor should open up a file for the guarantor and submit an invoice addressed to them for the advice. Given that the loans are for the benefit of the company, it would be appropriate for the guarantors to seek reimbursement of the same (although the VAT is unlikely to be recoverable).
8. "I have a cunning plan"
An often seen scenario on liquidation is as follows:
Director issues a guarantee to the bank. They then realise that the company is heading for insolvency.
As he knows his guarantee may be called, he neglects payments to other creditors in order to pay down the bank's facilities.
Unfortunately there is a flaw in this strategy, namely the Insolvency Act. In such circumstances, a subsequently appointed insolvency official, may be able to challenge/set aside the additional payments to the bank as preferences.
9. Know your subrogation rights
As stated above, the bank will often make a demand of the guarantor before looking to its other security. If the guarantor settles the bank's entire debt, the guarantor may have the right to the benefit of the bank’s other security. This process is known as subrogation.
10. PG now EFG
Businesses with a turnover of up to £25 million can apply through the Enterprise Finance Guarantee scheme for a bank loan of up to £1 million (with the government guaranteeing 75% of the loan). Through the scheme, the UK Government is currently providing up to £1 billion of guarantees to support £1.3 billion of UK bank lending.
However certain conditions must be met. One of these is that other sources of security have been exhausted. If a director has granted the PG, consider the possibility of applying for an additional EFG loan.
It should also be noted that the EFG scheme currently prohibits banks from taking charges to secure PGs.
Potential guarantors should not be pressured to sign the first PG proposed by their bank. Before committing to any PG, it’s vital to always take proper legal advice.
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