Directors personal guarantees

Startups and SMEs without an established trading history may find it difficult to obtain credit from banks or enter into deals with landlords and suppliers. In order to solve this problem, personal guarantees may be used. A personal guarantee is where one or more company directors personally guarantees to repay any debts of their business if the company is unable to meet its financial obligations, effectively putting their own personal assets at risk. A director's personal guarantee may be used in a variety of situations, including:

• bank loan or overdraft applications
• invoice financing (discounting and factoring) arrangements
• commercial property (eg where a business is a tenant)
• trade supply deals (eg where payment is not made in advance)
• investment deals

There is sometimes a cap applied to directors personal guarantees, which allows the director to limit the potential level of their financial liabilities.

The main advantage of directors' personal guarantees is that they provide new or small companies, which lack sufficient credit ratings, with access to finance and allow them to rent property or enter into supply agreements which they would otherwise be unable to do.

Although personal guarantees may be vital in getting a business off the ground, if they are relied upon and company debts become uncontrollable, the fallout can create significant stress for the directors and may eventually lead to them losing their family home or becoming personally bankrupt. If personal guarantees are not capped, they remove one of the key benefits of setting up a limited company as opposed to being a sole trader or partnership (ie limiting the liability of company owners).

Directors who provide personal guarantees may be prevented from voting on certain matters, subject to the articles of association, due to potential conflicts of interest (eg if the company wants to take a financial risk but the director does not want to expose themselves to further liability).

If a company encounters financial difficulties, directors should avoid preferential treatment to certain creditors on the basis of personal guarantees (eg paying a creditor with whom they have a personal guarantee before other creditors). Company debts must be paid as they fall due rather than out of a desire to protect personal exposure to liability.

Some lenders may seek to add an indemnity to a personal guarantee. Indemnities go further than personal guarantees in that, if for any reason the underlying agreement between the lender and borrower fails, the lender can still rely on an indemnity.

A guarantee is a promise that if the borrower (the company) does not pay their debts, the guarantor (the director) will be obliged to make good on what is owing. It creates a secondary obligation - which means that, if the company is not liable, then neither is the guarantor. In contrast, an indemnity is a primary obligation on the company director to recompense any loss to the lender, whether or not the company is liable.