It is common knowledge and, indeed settled case law, that a lawfully incorporated company has a ‘separate legal personality’ from its shareholders and directors, as set down by the House of Lords in Saloman v Saloman [1896].
Simply, the obligations of a company are the company’s alone; the corporate veil separates the company and the people running it, under which the latter, are not held responsible for the company’s liabilities. Naturally, there are exceptions to this rule, but they are generally limited to when a company becomes insolvent or where the company has been used as a sham or façade.
Why a Guarantee?
Taking into account the above, financial institutions and lenders have resorted to additional measures of security in order to protect their position when providing loans to companies. One of the most common and desirable options from the creditor’s perspective is a personal guarantee. In effect, a director’s personal guarantee is a mechanism in which the corporate veil is pierced thereby transferring liability from the company to the individual(s) behind the corporate entity.
The purpose of the guarantee is for the creditor to be able to demand payment from the individual, if the company defaults. Personal guarantees are usually on either a limited (capped liability) or unlimited basis. An unlimited guarantee means that the individual is guaranteeing that the lender will, potentially, be able to recover 100% of their debt including legal fees. Personal guarantees are legally binding and it is good practice for the individual to seek independent legal advice before signing any documentation.
Enforcing the Guarantee
If the individual cannot or will not, pay the debt owed, the creditor has two options of recovery and enforcement of the debt against the individual:
- Begin legal proceedings for a county court judgment ('CCJ'); or
- Petition for the individual’s bankruptcy
By securing a CCJ against the individual, the creditor can enforce the debt against the individual’s assets. Generally, the individual’s highest value asset will be their family home. The creditor may push for a charging order (‘CO’) over the property. By securing the CO, when the property is sold, the proceeds of sale will be used to satisfy the CCJ sum plus costs and interest. By securing a CO over the property, the creditor can also take steps via an Order for Sale to sell the property and recover the debt owed.
As an alternative to a CCJ, the creditor may decide to make the individual bankrupt, pursuant to the Insolvency (England and Wales) Rules 2016. For an individual to be made bankrupt, they have to be in a position upon which they cannot pay their debts as and when they fall due. If this appears to be the case, the Court will grant a bankruptcy order against the individual. Once the order has been granted, the individual forfeits their assets to the Official Receiver (‘OR’) who will administer the assets to satisfy the debts owed to the relevant creditors. The bankruptcy period concludes 12 months to the date of the court order and the individual will be free from their debts.
However, assets that are part of the bankruptcy stay under the OR’s control, as it can take time for all of the assets to be dealt with. Whilst the individual will be removed from the Individual Insolvency Register within 3 months of the discharge, the OR will not tell the credit agencies when the bankruptcy ends. The bankruptcy can stay on the individual’s record for 6 years after the date of the bankruptcy order and it is highly likely that the individual will struggle to gain access to any form of decent credit offer or agreement.
The Guarantee and Insolvency
Taking into account the above, guarantees are to be viewed as a additional measure of security for creditors and are usually drafted so that they can be called upon before the company becomes insolvent. A personal guarantee is not a secured liability, it is unsecured, and the debt remains unsecured unless steps are taken to change this i.e. a debenture on the company assets via fixed or floating charge, or a fixed second, charge on personal assets such as the family home.
It is highly likely that any loan signed by a director is likely to have a clause which allows the lender / creditor to recall than money at any time. Often referred to as the ‘Insolvency Clause’ this is a further protective measure of additional security for the lender, making sure than even in cases of insolvency, the debt will still be recoverable.
Administration
The theory behind administration is that a company which has fallen upon hard times, is given a feat of grace by providing a form of security by putting a protective ring-fence around their financial affairs. An administrator will take the reins of the company and work on a plan to provide the best outcome to satisfy the company’s creditors. In cases of insolvency (including administration), the creditor can demand payment from the individual in full via a statutory demand. If payment is not forthcoming, the creditor can proceed with bankruptcy, as detailed as above. Simply, the guarantee falls out of the limited liability offered to directors of a limited company.
Liquidation
As with insolvency, the guarantee for a business debt remains unsecured when a company enters into liquidation. The only exception to this would be if the guarantee is supported with a charge on the company assets – a debenture. The creditor will still be able to pursue the individual pursuant to the guarantee and the liquidator will not be able advise the individual as they will be acting for creditors by realising the company’s assets.
Hire Purchase or Finance Lease Personal Guarantees
For Small to Medium Company’s (‘SMEs’) they are often faced with the prospect of providing a guarantee in order to access the equipment or finance that their business needs to expand. In regards to hire purchase personal guarantee agreements, it is vital to identify who owns the asset (right to title). The relevance of the personal guarantee is that the directors may be able to sell the assets as opposed to the finance company. Clearly, a director with a personal guarantee on a hire purchase agreement has a vested interest in obtaining a better return for the asset than the creditor who will look to dispose the asset as quickly as possible before falling back on the guarantee(s).
Guarantee’s are an increasingly popular security mechanism being employed by finance companies to protect their position when dealing with SMEs. The guarantee not only pierces the corporate veil of the company, it places direct liability on the individual if the company defaults. By doing so, a whole host of enforcement and recovery options are available to the finance company which, invariably, offer a stronger recovery rate than pursuing a limited company with little to no assets. Guarantees should not be entered into lightly and for those who are considering taking such enforcement action, we would recommend that they discuss their situation with us to see if we can be of assistance.
Written by : Sean Dowling, Solicitor, Defended Litigation team
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