Personal guarantees are largely seen in relation to corporate borrowing and require a commitment that extends beyond the corporate veil.
It reinforces the guarantor’s confidence and commitment in the venture, and for lenders it provides an additional layer of security in uncertain markets or in instances where the borrower has a limited track record. It also, on the face of it, provides an alignment of interests between director and lender in a risk scenario.
Frequently, the implications of enforcement can seem remote to the borrower at the start of the lending journey, particularly in relation to the potential impact on personal assets - although, increasingly, guarantors are looking at options to mitigate their own risk, which may inadvertently create tension with the lender's position.
Enforcement: A legal and leadership challenge
In our experience, enforcement is not merely a legal exercise, it’s a test of stakeholder management and, as such, is not taken lightly. It requires the lender to balance short-term recovery against long-term reputational damage and the potential erosion of future opportunities.
Again, in our experience, lenders will generally prefer a pragmatic resolution over litigation and will generally accommodate workouts, informal settlements or refinancing, attempting where possible to preserve relationships while still mitigating risk.
In an environment marked by economic volatility and geopolitical uncertainty, thoughtful enforcement is not only a legal imperative but also a leadership opportunity, which involves protecting brand equity and demonstrating principled risk management.
Most guarantees will not require the lender to exhaust all avenues of enforcement against the borrower before enforcing against the guarantor.
How Personal Guarantee Insurance works
Recently, we have seen situations where directors have incepted personal guarantee insurance, intended to meet a percentage of the personal exposure if the guarantee is called on (typically 60% to 80%).
The insurance policy also requires, as a condition of the insurance, that if the company approaches a formal insolvency process, then only a firm on its nominated panel can be appointed. If not, then the insurance policy is invalidated and will not pay out.
Such a stipulation places directors in a very challenging position in instances where a secured lender has instigated recovery action and nominated their own practitioner, as is their prerogative in accordance with their security documentation. It can also be very disruptive where advisers have already been appointed to run a strategy, which ironically can then have serious adverse consequences on the outcome for creditors, including the insurer and the director.
Once appointed, the insurer’s practitioner is required to undertake an investigation of the directors’ activities and to specifically examine whether any of their actions or inactions have invalidated the policy.
Legal tensions and insolvency control
Some may question how an insurer can or should be permitted to dictate the course of an insolvency appointment when they are generally not a creditor in what is a creditor-driven process.
At best, they are arguably a contingent creditor. At worst, they will have no claim at all, yet the policy terms effectively seek to circumvent the provisions of the insolvency legislation and even further, assumes the director has a degree of agency and control in situations where he frequently does not. From the insurer's perspective, they are at risk of acting as a shadow director when instructing the directors to take measures which appear to only be in the insurer's interest.
What directors and lenders should consider
Directors should, consequently, consider their ability to adhere to this requirement when initially seeking cover and fully understand the implications if they are unable to control the choice of insolvency professional.
It is somewhat contrary that a guarantee which prima facie bolsters a lender’s position could undermine it. Lenders should consequently be aware of this product and the potential conflicts it can create.
In theory, for a director, insuring a personal guarantee looks like a smart hedge, an expensive but effective way to manage risk and personal exposure. But in reality, the insurer meeting a claim is far from guaranteed.
Ultimately, paying for a policy is different from receiving a payout.
Guarantee insurance is not a complete panacea. Its appeal lies in the promise of risk transfer, but this promise is encumbered by high costs and operational complexity, with policy terms dense with exclusions and stipulations which can conflict with the duties and responsibilities of a director.
