What happens to a personal guarantee in an insolvency?

SPONSORED: Lenders asking for a personal guarantee is common for startups, higher risk businesses or companies with a limited track record or poor credit history. While personal guarantees are often seen as a necessary evil for securing financing or favourable terms, they can significantly increase the personal risk for company directors and owners.

by | 23 Jul, 2024

A professional gives advice to a client

One of these risks is the consequence of the business entering insolvency which will trigger a personal guarantee liability.

This article will help you to understand the implications of your client entering insolvency with a personal guarantee exposure and explore options that could mitigate their personal liability.

Personal guarantees and limited companies

One of the main advantages of operating a business through a limited company structure is that it provides liability protection for the owners and directors.

However, personal guarantees from the company’s directors or shareholders effectively overrides this liability protection. Entering an insolvency process doesn’t remove this risk.

If the company encounters financial difficulties or fails to meet its obligations, the personal guarantor may be held personally liable, potentially leading to bankruptcy. This may result in seizure of personal bank accounts, future earnings or even force the sale of your client’s home or other valuable assets.

Suggestions for negotiating personal guarantee terms

Let me say first that this is not legal advice. If your client is seriously considering securing finance by providing a personal guarantee, I would always advise them to take independent legal advice before signing anything.

This is intended to give you pointers so that when presented with a personal guarantee, you know how the terms might be amended to be more favourable for your client.

  • Limit the guarantee amount: Instead of an unlimited personal guarantee, negotiate a cap on the maximum amount your client will be liable for. This could be a fixed sum or a percentage of the total debt.
  • Include a release clause: Seek a release clause that terminates personal liability under certain conditions, such as the company achieving specific financial milestones.
  • Restrict the guarantee scope: Negotiate to limit the personal guarantee’s scope to specific assets of the guarantor.
  • Set an expiration date: Propose an expiration date for the personal guarantee, after which it becomes void, providing a time limit for their personal liability.
  • Require consent for changes: Insist on a clause that requires your explicit consent for any changes to the terms of the underlying credit agreement or personal guarantee.

When to avoid giving a personal guarantee

While personal guarantees are often demanded by lenders and creditors, there are certain situations where providing one can be extremely risky. It’s crucial that your client is cautious and avoids giving a personal guarantee in these circumstances. This is where your advice can be invaluable.

Is their business model unstable? If your client’s business is not profitable or operates in a highly volatile industry, the risks associated with a personal guarantee may outweigh the potential benefits. An unproven business model increases the likelihood of defaulting on loans.

Do they struggle with cash flow? Taking on additional debt might be a crucial part of your client’s plan to grow or stabilise their business. But if it’s secured by a personal guarantee, it can be a recipe for disaster. If they’re already struggling to keep up with payments, increasing the amount of debt isn’t a good idea.

Richard Simms, Managing Director of FA Simms

Are their personal finances overextended? Protecting your client’s personal assets should be a priority in this case. If they’re already stretched thin, adding a personal guarantee to the mix can put them in an even more precarious financial situation.

Have they presented unrealistic growth projections? If the loan or investment they’re seeking is based on overly optimistic growth projections or unrealistic financial forecasts, it’s wise to exercise caution. Failing to meet these projections could lead to defaulting on the loan.

Do you have a lack of trust in partners? If you have doubts about the integrity or competence of any of the business partners, providing a personal guarantee can be an unnecessary risk. Mismanagement or misconduct could jeopardise the business and trigger a personal guarantee liability.

Are there unfavourable terms in the contract? As I said above, carefully review and negotiate the terms to ensure they’re fair and reasonable before committing. If the terms of the personal guarantee are excessively onerous or one-sided, it may be better to walk away from the deal.

Entering insolvency with a personal guarantee

When a company becomes insolvent or enters a formal insolvency process, any personal guarantees signed by directors or other individuals are likely to be enforced by the lender.

Creditors with guarantees can pursue the guarantor for the repayment of the debt even after the company’s debts have been settled through an insolvency process.

This is why it’s worth considering the implications with your client before they sign a personal guarantee.

Personal bankruptcy could provide some relief, as a bankruptcy discharge typically eliminates the personal obligation to pay back debts. However, this can have devastating personal financial consequences which will impact the guarantor for years.


How we can help

If your client’s worried about a personal guarantee they already have, or one they’re considering, FA Simms can work with you and them to assess the potential impact and carefully evaluate the alternative options.

Talk to FA Simms about your client’s situation by calling 01455 555 444 or emailing [email protected]

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