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What is a Personal Guarantee?
When money is lent to a company or person, a lender will usually seek some form of security over the borrower’s assets so that those assets can be realised (sold) in the event that the borrower cannot or does not pay. That might take the form of a mortgage over real property, a fixed charge over assets, or a debenture over all of a company’s property.
If a borrower’s existing assets are deemed insufficient to repay a lender, or even if a lender simply requires an extra layer of protection, the lender may also seek a “personal guarantee” as a further form of security for its borrowing. A personal guarantee works by way of an individual who is not the borrower essentially promising to repay – “guaranteeing” – the debts of the borrower in the event that the borrower defaults on repaying the lender.
In practice, personal guarantees are most commonly seen in corporate borrowing, where a lender will require a personal guarantee from a company’s directors or shareholders as a condition of the lending. That will mean that if a company defaults on its loans, the lender can pursue the directors personally– as “guarantors” – for the outstanding sums. In practice, many personal guarantees may be “capped” at a lower amount than the total of the borrowing, meaning a lender may in many circumstances not have the option of recovering their full loan from a guarantor.
When can personal guarantees be enforced?
The practicalities of enforcement on a personal guarantee will largely be governed by the loan documentation and the document recording the guarantee itself. These will specify the circumstances in which the guarantee becomes enforceable – usually referred to as an “event of default”. Common events of default include, among other things, the failure by a borrower to meet a repayment of its loan on a repayment date; the occurrence (or non-occurrence) of a particular event (most commonly seen in loans advanced for a specific purpose, such as a property development); or the commencement of insolvency proceedings against the borrower.
Personal guarantees will usually become automatically and immediately enforceable upon the occurrence of an event of default. Most guarantees will not require the lender to exhaust all avenues of enforcement against the borrower before enforcing against the guarantor (although in practice it is advisable to make some form of demand on the borrower, if only to demonstrate an inability to pay).
How can a personal guarantee be enforced?
When a personal guarantee becomes enforceable, it will be considered a “liquidated sum”, meaning that insolvency proceedings can be commenced immediately against the guarantor without the need to first establish a debt through the Courts. In practice, the lender will usually make a written demand of both the borrower and the guarantor, following which, if no acceptable proposals for repayment are forthcoming, bankruptcy proceedings can be commenced against the guarantor. That will involve the presentation of a statutory demand against the guarantor, followed by a bankruptcy petition if the demand is unpaid (or unsecured, or unchallenged).
Can a guarantor challenge a personal guarantee?
Generally speaking, if an event of default has occurred and the borrower cannot pay, it will be very difficult for a guarantor to challenge their liability under a personal guarantee. However, guarantors should carefully examine the wording of personal guarantees to determine precisely when their obligation to pay crystallises, how that takes effect and importantly what sums exactly the guarantee covers. While most institutional lenders have fairly comprehensive guarantee clauses, the documentation of other lenders or providers may be less clear.
It may also be possible for a guarantor to avoid liability even if a guarantee has crystallised in certain other, very limited circumstances. If a guarantor can establish that they entered the guarantee under duress, for example, or if it can be shown that the lender somehow caused the event of default by the borrower, then these may be grounds to prevent enforcement of a personal guarantee. These will, of course, be heavily fact-specific, and courts are unlikely to consider “commercial pressure” to be “duress” in any but the most extreme cases.
This article first appeared on Lexology. You can find the original version here.
