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Directors' personal guarantees

29/10/2014

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United Kingdom

Since the landmark case of Salomon v Salomon in 1897, it has been clear that a company has separate legal personality and is responsible for its own debts.

Good Company October 2014 edition


Since the landmark case of Salomon v Salomon in 1897, it has been clear that a company has separate legal personality and is responsible for its own debts.  Neither its directors nor its shareholders can generally be called on, even if the company is in default.

However, for smaller, owner-managed companies this often means that banks, landlords and even suppliers may agree to deal with the company only if its obligations are backed up by a personal guarantee from the individuals standing behind it.

Directors can be put under considerable pressure to give personal guarantees to get their company's business up and running and it is easy to be over-optimistic about the company's prospects.  But a guarantee will put the director's personal assets at risk and should not be given without a full understanding of the implications.

The effect of a guarantee

By giving a guarantee, the director promises that the company will fulfil its obligations, for example to repay a loan or to pay rent, and that he will do so if the company does not.  A guarantee is a secondary liability, which may be discharged if the company's obligation is varied or set aside, but it will usually also include an indemnity which would continue to apply in these circumstances.

If a claim is made under the guarantee, the director will be liable to pay the company's debt and, if he does not do so, the bank (or other beneficiary of the guarantee) will be able to take him to court and ultimately enforce a judgment debt against his assets, including the family home.

If the director does not have sufficient assets to cover the debt, he may be made bankrupt.  In addition to the effect on his credit rating and the difficulty of obtaining financial services, insurance and so on, an undischarged bankrupt may not act as company director without leave of the court.

If several directors give a personal guarantee (or give a single guarantee jointly and severally) to the same bank, it does not have to take action against all of them but can claim the whole amount from one guarantor.

Secured guarantees and third party charges

In many cases, the bank will also want to take security over the director's assets.  This would enable the bank to sell the relevant asset to meet any liability under the guarantee, without needing to go to court.

In the case of the family home, the bank would require the director's spouse or partner to join in giving the security if they co-own the property.  In addition to the risk of losing the property, giving a secured guarantee may also make it more difficult to move house.  The bank will generally require the spouse or partner to take independent legal advice before giving the guarantee: indeed, the bank may insist that the director should also take such advice, to reduce the risk of a challenge to the enforceability of the guarantee on grounds such as undue influence or misrepresentation.

Sometimes a personal guarantee and security over assets are combined in one document, called a third party charge.  Under this type of arrangement, the director's liability is usually unlimited, but in a "non-recourse" third party charge liability is limited to the value of the charged property with no further recourse to the director or his assets if the sale of the property does not generate sufficient funds to settle the company's debt.

Points to negotiate

The first question is whether a personal guarantee is really necessary.  Can the bank be persuaded that the company is able to provide sufficient security?

If the bank insists on a personal guarantee, it should, if possible, be linked to a specific loan rather than being an "all monies" guarantee of all the company's borrowings from time to time.  Otherwise, the director should negotiate a cap on the amount he can be asked to pay under the guarantee.

The director would also want a provision enabling him to terminate the guarantee as to future liabilities of the company, in particular if he ceased to be a director.  The bank may be reluctant to agree to this, unless alternative security can be provided or the outstanding amount of the loan is repaid.

If the director wants enforcement of the guarantee to be conditional on the bank having first enforced its security over the company's assets, this should be expressly set out in the guarantee.  This was the result of the recent Court of Appeal decision in National Westminster Bank v Alfano, where directors failed in their claim that personal guarantees they had given were conditional on the company giving the bank a debenture over its assets which would be enforced before the bank made any claim under the guarantees.

Directors' duties

A director who gives a guarantee will need to declare his interest in the relevant transaction to the other directors, and may be prohibited from voting under the company's articles of association (although there is often an exception for guarantees even if the articles do restrict directors' voting rights).

The guarantee will also place a director in a situation where his interests may conflict with those of the company.  This situation should be approved by an ordinary resolution of the shareholders or, if the articles of association permit, by the other directors.

If the company gets into financial difficulties, a director should not cause it to pay off a creditor to whom he has given a guarantee before other creditors.  Any such preferential treatment would be a breach of duty and could be unwound by the court.

Danielle Harris is a Senior Associate and Professional Support Lawyer in Fieldfisher's Corporate Group in London.

This article is based on an article written for Company Secretary's Review, published by LexisNexis.

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