As owner and director of your own small business or personal service company, no doubt one of the key reasons you decided to incorporate was to limit your liability.
As a separate legal entity, the liability of a limited company is generally restricted to its capital and assets, meaning that your personal assets are protected.
However, as you may have already discovered, in the cutthroat world of modern-day business, requests for personal guarantees are becoming more commonplace, and such requests must be handled carefully.
In this article, we will discuss personal guarantees in more detail, why they’re requested, how they increase your risk, and why you need to be aware of them.
What is a personal guarantee?
In brief terms, a personal guarantee is a document (or clause within a document) where an individual acting on behalf of a company (usually a director) is asked to personally guarantee an obligation of the company.
Where are personal guarantees typically used?
A personal guarantee could be used when a company enters a legal obligation and additional security, or comfort, is requested to support that obligation. Common scenarios included trade contracts, consultancy contracts, commercial lease agreements, and finance and banking commitments.
Why are personal guarantees requested?
A personal guarantee is typically requested where the other contracting party has reason to believe that the company lacks the resources or asset base to meet the contractual obligations being entered into by the company.
This may be because the company is a new company with no trading history or (as is the case with personal service companies) only exists as a vehicle to allow the key individual to work and, as such, has little or no asset base of its own.
Also, guarantees are commonly used whereby the relevant contractual obligations relate to areas whereby personal commitment is desired.
This may be across contract areas such as confidentiality, intellectual property rights and restrictive covenants, etc., which work better when restraints and obligations are set against or supported by individuals instead of their companies.
How does a personal guarantee affect my own liability?
If an individual enters into a guarantee, it can increase their liability hugely.
The contract allows the other party to enforce the contractual obligations directly against the individual and their assets without first having to seek recourse via the company.
Is a director’s guarantee the same as a personal guarantee?
Where a personal guarantee is requested from a company director, they’re essentially the same thing.
However, the term ‘personal guarantee’ is somewhat broader as, theoretically, one could be requested from a non-director shareholder or anybody else with a vested interest in the company.
Could a personal guarantee place my house at risk?
Potentially, yes. Since most people’s principal asset is their own house, if you enter into a personal guarantee, you could ultimately place your home at risk if you can’t meet the liability accruing from the guarantee.
If a court order is made against you and you cannot pay it, you may have a charging order registered against your home.
In a worst-case scenario, you could even be made bankrupt via a petition application, which could ultimately trigger the sale of your home and other assets, depending on the circumstances.
Clearly, this would only happen in rare circumstances, such as where the commitment is of a very high financial value and, as such, warrants the contracting party taking such steps.
Nevertheless, it demonstrates the degree to which caution has to be exercised whenever you are asked to give a personal guarantee, mainly if the potential liability is high/uncapped or the company commitment is in danger of not being met.
While setting up a limited company limits personal liability, personal guarantees expose individuals to direct enforcement of obligations, potentially endangering personal assets like homes. Caution is crucial when agreeing to personal guarantees, considering the high level of personal liability they entail.
Seeking legal guidance from LawBite can help mitigate risks, as their expert lawyers offer comprehensive services to navigate personal guarantees and protect individuals’ interests, ensuring business growth with peace of mind.
Ashley Gurr is a commercial and contract lawyer at LawBite. Ashley has over 15 years of experience in private practice helping SMEs and in-house for an international consultancy group advising on commercial agreements and a multi-national utility giant in a contract strategy role.