Last year, we speculated that the requirement for personal guarantees from directors could become less common as a result of the Recovery Loan Scheme (RLS). The RLS doesn't require directors' guarantees for loans of less than £250,000 and we felt this might encourage lenders that aren't accredited under the scheme to change their criteria in order to compete.
To be honest, we haven't seen any significant change in policies yet, although we did spot a press release from FIBR before Christmas promoting guarantee free loans of up to £500,000. The Dutch online lender provides revolving credit facilities and business loans from £10,000 to £500,000 for UK SMEs.
This then, seems to be an appropriate time to look at why lenders seek guarantees and what the implications are of giving one.
Most lenders will summarise their need for a director's guarantee as 'securing commitment'. They are very aware of the limited liability nature of a limited company and don't want to be left with a bad debt should the business fail. Their argument is that if you are confident enough in your business's ability to repay the liabilities that it is taking on, you shouldn't have any issue with guaranteeing it (the counter argument is that they are charging you interest for the risk they are taking, but it's an argument you are unlikely to win). The lender wants to know that you will be motivated to do everything in your power to make sure the business can pay it back.
Unsurprisingly, guaranteeing a loan means that you agree to repay the loan personally in the event that the principal borrower, in this case, your company, can't repay the loan itself.
The small print can make it even more nuanced than that. Most guarantees are written as indemnities, which means the lender can call on you, even if it hasn't exhausted all possible means of recovering the money from the company. A guarantee from two or more directors is also likely to be 'joint and several', which means that the lender is able to call on any one of the guarantors for all of the money. You will not be guaranteeing only a proportion of the loan unless the guarantee is specifically written that way.
Your guarantee could be deemed as worthless if you don't have the personal means to back it up, and even if you do, it could be difficult for the lender to enforce it if it doesn't have control of any of your personal assets. For this reason, lenders will sometimes ask for assets to be pledged in support, most commonly, this is by way of a second charge over your property. The amount of the facility is likely to determine whether the lender will look for any supporting security for the guarantee. Each lender has its own policy, but generally supporting security enters the conversation when advances are over £50,000.
The Recovery Loan Scheme has changed the landscape here somewhat as lenders using the RLS are barred from seeking a charge over a director's principal home. This, however, only applies to facilities agreed under the RLS.
If there is any doubt in your mind about what you are signing, you should certainly seek independent legal advice. Most lenders won't insist upon it if you are actively involved in the running of the business as it has been proved in past case law that they can rely on you having sufficient business acumen to know what you are signing. However, where the guarantee is also provided by somebody not actively involved in the business e.g. a spouse, the lender can insist on the other party getting advice. This is to prevent a defence in the event of a claim of one party having exerted undue influence on the other to sign.
While there are undoubtedly examples of lenders deciding not to pursue directors under their guarantees, perhaps taking a view on the liklihood of recovery, you have to enter into it in the full expectation that the lender will. The guarantee is a legally binding document and the lender has every right to call upon it if it needs to.
Things can go wrong for even the best run businesses. If that happens, the best advice is always to enter into an early dialogue with the lender. There is a good possibility that the facility can be restructured to buy the business a bit more time. You might even talk to a business restructuring expert to explore the options around recovery or liquidation. Your priority is to find a way for the business to pay the debt before the responsibility falls to you.
There are insurance products on the market that directors can buy, which will pay out in the event of a claim. These products also provide support with negotiating with lenders to minimise the amount they seek to recover. The premiums are linked to the amount of the loan, the term outstanding and the credit rating of your business. Our experience is that these policies are expensive, that said, there is a place for them and it is worth getting a quote to see if it is right for you. An example quote obtained for the purposes of this blog came in at £305 per month for £100,000 of cover.
Guarantees are likely to remain an integral part of business borrowing for the foreseeable future. While it can be justified to provide one in the right circumstances, you must enter into it with your eyes wide open. A guarantee is easily signed, but far from a meaningless piece of paper.
Please contact us for advice on any of the issues raised in this blog and, of course, for help with navigating the requirements of different lenders if you are in the market for business finance now.
Photo by Cytonn Photography on Unsplash