Corporate insolvency, including the Small Business Restructure (SBR) process, can have serious, sometimes unforeseen, consequences for company directors. Often, these consequences only become apparent when financial trouble arises.
While company directors are generally not personally responsible for company debts, there are exceptions—particularly when personal guarantees are involved.
Do you know you’re personally liable when you sign a personal guarantee?
At Collective Financial Partners, we often see directors who have no idea of the full implications of signing personal guarantees.
Below we outline some of the key things that are often missed.
Always seek legal advice before signing personal guarantees to understand the full risks and obligations.
What is a Personal Guarantee?
A personal guarantee is an individual’s legal commitment to pay a business’s debt if that business defaults.
A personal guarantee is a legal promise made by an individual, often a director, to cover a company’s debt if the company can’t pay. It’s a simple concept, but the consequences can be big and often unexpected.
How they work
A personal guarantee is a legal agreement where an individual, often a director, takes on personal liability for a business debt if the business defaults. This means if the business can’t pay its bills, the lender can come after the director’s personal assets to recover the debt.
Lenders often require personal guarantees for small businesses or startups that don’t have an established credit history or sufficient assets to secure a loan.
In practice, this means the director puts their personal assets, such as their home or savings, on the line. If the business defaults, the lender can seize these personal assets to cover the debt.
Personal guarantees can be limited or unlimited. A limited personal guarantee limits the amount of personal assets at risk, an unlimited personal guarantee puts all the director’s personal assets on the line. Understanding the terms and risks of a personal guarantee is key before signing any agreement.
Types of Personal Guarantees
Personal guarantees come in two forms – limited and unlimited personal guarantees. Each has different implications for the guarantor.
A limited personal guarantee requires the director to put a specific amount of assets on the line, capping their personal liability. This is often used for smaller loans or businesses with an established credit history.
An unlimited personal guarantee requires the director to put all their personal assets on the line, exposing them to big risk. This is often used for bigger loans or high-risk businesses.
Another type is the joint and several personal guarantee. This is where multiple directors or guarantors put their personal liability on the line collectively and individually for the debt. If one guarantor defaults, the others can be held personally liable for the full debt.
Understanding what type of personal guarantee you’re signing is critical as it directly impacts your personal financial risk.
Common scenarios where personal guarantees apply when a company defaults.
Supplier Accounts
When suppliers offer credit terms to a business, they often require the director to sign a personal guarantee. This makes the director personally liable for any unpaid invoices if the company can’t pay its bills —such as in the event of liquidation. In addition to the unpaid debt, the director may also be liable for interest and legal costs.
A little-known detail in the fine print is the “Charging Clause.”
This clause allows the supplier to secure their debt by charging the director’s personal assets, including real estate. In practice, suppliers can put a caveat on a director’s property to ensure repayment.
In effect, signing a personal guarantee could result in your assets being treated like collateral—like a mortgage!
General Secured Loans
Banks and other lenders often take security over real property (like a family home) for loans to small and medium-sized businesses.
If the company defaults, the bank can enforce the loan against the secured property and put your personal assets at risk.
Asset-Specific Loans (Chattel Mortgages/Finance Agreements)
When banks finance an asset like a vehicle, they typically take security over the asset itself.
However, if the asset’s sale after repossession doesn’t cover the outstanding debt (the “Shortfall Amount”), the director may still be liable for the remaining debt under the directors’ personal guarantees, which can also be secured by personal assets through a Charging Clause.
Unsecured Loans
Lenders often ask for personal guarantees from directors, even for loans that don’t require company assets as collateral.
A personal guarantee means an individual’s legal commitment to pay back a business’s debt if the business defaults. So, a director may unknowingly put their personal assets (like their home), on the line for a business loan.
Piercing the Corporate Veil
Piercing the corporate veil is key to understanding personal guarantees.
Normally a company is a separate legal entity that protects a director’s personal assets from business liabilities. However, this protection can be bypassed when a personal guarantee is in place. If the company defaults on its obligations, the lender can “pierce” the corporate veil and take after the director’s personal assets to recover the debt.
This legal mechanism makes directors personally liable for business debts, which breaks down the usual separation between personal and corporate finances.
Personal guarantees are a common tool used by lenders to ensure they can get their money back even if it means going after the director’s personal assets.
Directors should be aware of this risk and consider it when signing personal guarantees.
Get Formal Legal Advice
To best protect yourself from the risks of a personal guarantee, get formal legal advice before signing one.
A lawyer can explain the terms of the agreement and the risks involved. This is critical to make sure you’re not putting your personal financial stability at risk. Independent legal advice will give you an objective view of the guarantee and help you make an informed decision.
You should also understand what happens if you default on a personal guarantee.
If you default, you could be personally liable for the debt and your personal assets could be at risk. Reviewing the terms of the guarantee with a lawyer will help you understand your obligations and liabilities and make sure you know what you’re signing up for.
Personal guarantees can affect your credit score.
If you default on a personal guarantee, it can damage your credit rating and make it harder to get credit in the future. This is another reason to think carefully before signing a personal guarantee.
Before signing a personal guarantee get formal legal advice to understand the full extent of your obligations and the impact on your credit score. Being informed will help you make a decision that protects your financial stability and doesn’t put you at risk.
Key Points
Personal guarantees are part of doing business, but they shouldn’t be signed without careful consideration.
- Always seek professional advice and thoroughly review the terms before committing to a personal guarantee—especially the Charging Clauses.
- Get legal advice before signing any personal guarantees to understand your personal liabilities and obligations. Independent legal advice will protect you from the traps.
- If you are no longer involved with a business, notify suppliers and lenders immediately and request the release of any personal guarantees.
- If financial trouble hits, get professional advice fast. Collective Financial Partners can help you navigate these situations and protect your personal assets.
Please contact us if you want more information or guidance on personal guarantees and how they affect you.
Attribution: This item is based on an article by Daniel Luckman of specialist insolvency accountants, SV Partners.
