Personal guarantees: an essential guide

At Morr & Co, we are often approached by company directors who have agreed to personally guarantee loans or other liabilities assumed by their companies.

The provision of a personal guarantee is often a necessary pre-condition to obtaining finance from third party lenders. It may sometimes be given with only limited thought to the potential consequences for the guarantor, if matters do not work out as intended and the guarantee is called in.

In such circumstances, a guarantor can find themselves exposed to significant personal liability putting their own assets at risk.

If you are asked to provide a personal guarantee, then we would always recommend that you seek advice on the terms of the guarantee before entering into it.

This may avoid any potential misunderstandings and helps to proactively manage risk. However, we are regularly asked to advise on the terms and effect of personal guarantees after the event.

In this article, we look at a number of the common questions raised relating to personal guarantees and potential arguments that may be deployed in response to a claim made under a personal guarantee.

What is the effect of a personal guarantee?

In short, by providing a personal guarantee, the guarantor is assuming a contractual liability to fulfil the obligation of a third party in the event that it fails to do so.

For example, if a company enters into a loan agreement, the primary obligation to repay the loan falls on the company. However, where a personal guarantee is also obtained, this imposes a secondary obligation on the guarantor to repay the loan in the event that the company defaults.

Personal guarantees will often be sought where there are concerns about the borrower’s solvency.

Does a personal guarantee need to be given by deed?

There is no legal requirement that a personal guarantee be set out in the form of a deed. However, this is common practice.

If the guarantee is not in the form of a deed, then it must comply with the ordinary principles of contract law and be supported by consideration. If the guarantee is not executed as a deed, and is not supported by consideration, then it will be unenforceable.

If the guarantee is in the form of a deed, it is important that it is properly executed. The formalities to be followed differ depending on the nature of the party entering into the document.

For individuals, the document must be signed by that individual in the presence of a witness who attests the signature and delivered as a deed.

For companies, a deed can be executed by affixing its common seal or by the signature of either (a) two authorised signatories (i.e. a registered director and a company secretary) or (b) a company director in the presence of a witness.

Does a personal guarantee need to be writing?

This may seem obvious, but in order to be enforceable, a personal guarantee must be in writing and signed by the guarantor, or a person authorised by the guarantor: section 4 of the Statute of Frauds 1677.

Does there need to an ink signature?

Increasingly, documents are not signed by hand but are executed using electronic methods such as DocuSign.

The English courts have long held what constitutes a signature for these purposes should be given a wide interpretation and it does not require an ink signature to be applied to the document.

However, the need for the signature to be attested by a witness still needs to be borne in mind.

Does a personal guarantee continue to apply if the guarantor ceases to be a director of the company?

This is a commonly asked question. The answer depends on the terms of the personal guarantee.

However, unless the document states otherwise, a director’s liability under a personal guarantee will not come to an end simply because they have resigned from their position as a director of the company.

In fact, it is unusual to see a personal guarantee that allows for termination on resignation, but even where there is such a clause, it will usually only protect the director from a default by the company that takes place after the date of resignation.

The personal guarantee will usually continue to ‘bite’ where the default took place prior to the date of resignation.

What if there are co-guarantors?

It is common for a company’s obligations to be guaranteed by more than one person. Where two or more people guarantee the same liability, they are referred to as co-guarantors.

If a claim is made against one guarantor, it may be possible for that guarantor to seek a contribution from their co-guarantor.

This allows a co-guarantor who has paid more than his or her fair share of the debt to seek a contribution from their fellow co-guarantor.

Do I need to obtain a deed of release once payment has been made?

Generally speaking, there is no need to request a deed of release.

If the obligation to pay under the personal guarantee has been met in full, and the payment is not invalid, then it will automatically operate to release the guarantor from further liability.

What is the limitation period for enforcing a personal guarantee?

Liability under a personal guarantee will generally only arise once the company defaults on its obligations or when the party with the benefit of the guarantee satisfies any condition precedents, such as sending a letter of demand to the guarantor.

If the guarantor then fails to make payment, the period within which court proceedings must be brought depends on whether the guarantee was executed as a deed or as an ordinary contract.

If it was validly executed as a deed, then the applicable limitation period is 12 years, whereas if it was validly executed as an ordinary contract, the applicable period is 6 years.

Does a claim need to be made against the company before pursuing a claim under the personal guarantee?

The party with the benefit of the guarantee will generally have the option of pursing the guarantor immediately without first claiming against the company or claiming against both the company and the guarantor at the same time.

However, it is always worthwhile checking whether the company’s obligation to pay is conditional upon a demand being made. If so, a demand will normally need to be sent before a claim can be made against the guarantor.

What if there has been duress and undue influence?

If a party has entered into a personal guarantee under duress, then the agreement is potentially unenforceable.

Duress in this context can include threats to the individual, threats to property and economic threats, including a threat to bring a contract to an end unless certain steps are taken.

A guarantee may also be rendered unenforceable if it was obtained through undue influence or misrepresentation.

These types of issues typically arise where the relationship between the borrower and the guarantor is personal in nature and is considered “non-commercial”.

The classic example is where the parties are husband and wife, which was considered in the case of Royal Bank of Scotland plc v Etridge (No. 2).

This case gave rise to the Etridge principles setting out the guidelines that banks and other financial institutions are expected to follow when on notice of a potential risk of undue influence.

Points to consider if you find yourself subject to a claim under a guarantee

1. Has the guarantee been executed as a deed or as an ordinary contract? If it was executed as a deed, has it been signed by the correct parties in the presence of a witness or otherwise in compliance with the requirements of the Companies Act? If it was executed as an ordinary contract, is there valid consideration for the obligations set out in the guarantee? In either case, did the guarantor have capacity to give the guarantee? If there has been a failure to follow the applicable formality requirements, the guarantee may be unenforceable.
2. Were the consequences of signing a personal guarantee explained prior to sign off? Were you offered the opportunity to obtain independent legal advice on the effect of the guarantee? Were you pressured into entering into the agreement? One of the grounds on which the validity of a personal guarantee can be challenged is undue influence or duress.
3. Have the terms of the personal guarantee been altered after it was signed? Any amendments should be made by consent and if consent was not obtained, this may render the amended agreement unenforceable.
4. Has the trigger for liability under the guarantee been engaged? If the company has not become liable for the debt because the lender has failed to serve a demand under the loan agreement, then the lender may not be able to call on the guarantee. Check for any pre-conditions that need to be met under the guarantee to ensure these have been satisfied in full.
5. Has the claim been pursued in time? There are fairly generous time periods for bringing claims under a guarantee, especially where the document is executed as a deed, but it may be that the document itself imposes a more limited period within which any claims must be notified and/or issued at court.
6. Engage with a claim at the earliest possible opportunity. Ignoring a claim can have severe consequences and is only likely to lead to costs escalating which may make it more difficult to resolve the dispute. By engaging with a claim at an early stage, you will have the best possible opportunity to resolve the matter quickly and avoid an increase in costs.
7. Seek advice on your options as soon as possible. Clearly it will not be possible in each and every case to avoid liability, but an early assessment of your options helps inform strategy and will potentially prevent costs being incurred unnecessarily.

How can Morr & Co help?

Personal guarantees carry significant risks and understanding their terms is crucial both before signing and when facing a claim.

If you have any concerns or questions, please do not hesitate to reach out by calling our Dispute Resolution team on 01737 854500 or email info@morrlaw.com

Disclaimer
Although correct at the time of publication, the contents of this newsletter/blog are intended for general information purposes only and shall not be deemed to be, or constitute, legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article. Please contact us for the latest legal position.