Workshop: Beware the risks attached to giving personal guarantees

Solicitors can find themselves facing a difficult dilemma when advising companies and their directors if a situation arises when the business's bank or landlord, a supplier or factor suddenly demand personal guarantees to support the company's obligations.

As a general rule the first step should ?be to explore with the clients any possibility of avoiding giving guarantees at all by looking for potential collateral within the business, such as a charge over book debts or an intellectual property portfolio. In many cases that will be insufficient to satisfy the lender.

The principal concern for the lawyer must be to consider the potential impact of clients giving guarantees, bearing in mind the possible ramifications for their own resources and those of their families.

Business failure

Inevitably, the majority of guarantees only get called when a business has failed. Assuming that this was the principal source of income for the guarantor, it means the demand may well be made at a time when he or she is least able to meet the obligation other than by realising personal assets, perhaps in unfavourable market conditions.

So when advising potential guarantors, look carefully at their overall financial position; consider whether all the key family assets are vested in the guarantor, or whether a proportion be safely spread through the wider family. It is no use waiting until a call is made. Any transfers made in the period immediately prior to a demand being received is most likely to be set aside, especially if the demand cannot be met in full. But there is nothing improper in working with the client to arrange their financial affairs, so as to mitigate their potential loss when times are good - and don't overlook the impact of potential legacies, which may require you to recommend that wills are rewritten.

Third-party guarantees

As part of the planning process, it's never too soon to consider the possibility that ?at some stage business borrowings are ?going to need to be supported by ?third-party guarantees.

So, when drafting shareholders agreements, consider the merits of including provisions obligating the shareholders or directors to support the company by offering personal guarantees as and when the requirement arises.

However, one aspect which is commonly overlooked and which requires appropriate attention, is that if guarantees are to be given, they should fairly reflect the party's underlying share in the business.

It is unfair for someone who only has ?a minority interest in the business, to have to give a guarantee (whether joint or several) which would create a significant exposure disproportionate to their interest in the business.

Even if the opportunity is missed when the shareholders agreement was drafted, a further chance occurs to ensure fairness between several guarantors at the time that the financial institution decides that it wishes to require personal guarantees.

It is good practice to discuss with the potential guarantors a number of aspects including whether or not the guarantees are to be joint or several, whether they are to be for similar or different amounts, whether they are to be secured on assets owned exclusively or on assets owned jointly by the guarantor and their partner or some other third party.

Financial transparency

Press also for some financial transparency between the individual guarantors; it is no comfort for one guarantor to relax knowing that he is one of a number if it later transpires that the others are simply 'men of straw'. This may lead to some difficult discussions between the parties involved, but is only equitable to identify the strengths of the individual guarantors assets and to try and address potential issues while times are good, rather than wait until the letter arrives from the bank or the landlord calling on the guarantee.

Try to encourage clients to agree to enter into a deed formally committing them to contribute between each of them in predetermined proportions.

Of course, there will be the need ?to consider whether each guarantor ?requires separate advice to avoid any conflict of interest; clearly the solicitor instructed by the guarantors needs to ensure that he acts fairly towards each ?of them, with the aim of achieving an equitable outcome.