Personal guarantees – a brief guide on enforceability
It’s quite common for directors of SMEs to be required to give personal guarantees in respect of their business’s corporate borrowing. In the good times, those guarantees may well have been filed away with no real expectation that they would ever be called upon.
However, in the face of rising interest rates, significant increases in utility costs, and the overall prospect of more challenging economic times ahead, it may very well be that more businesses will begin to struggle. This in turn could lead to more lenders dusting off historic personal guarantees given by directors in order to recover unpaid debts.
Against that backdrop, Mark Turner, Partner in our Commercial Dispute Resolution team outlines some of the key elements of an enforceable guarantee and areas to consider when looking at whether there may be grounds to challenge a demand made under a guarantee.
Is the guarantee valid?
There are few formal requirements that a guarantee must comply with – but failure to comply with them could render the guarantee unenforceable, so it’s important to ensure that it does in fact satisfy them.
The Statute of Frauds, which dates as far back as 1677 but remains the primary legislation, sets out the formal requirements. The main one for a guarantee to be valid is that:
- it must be in writing; and
- it must be signed by the guarantor (or a person authorised on the guarantor’s behalf)
For this reason, a creditor will not be able to rely on a verbal assurance that the director will guarantee their company’s liabilities.
A guarantee is a contract in its own right, over and above the contract for which it is being given, and it must therefore comply with the basic requirements of a contract – including the need that there be “consideration” for the promise.
Consideration is a legal concept that a contract must involve a party giving something of value to which the other party is not already entitled, in exchange for contractual promises. This may be as simple as a promise that the guarantor will take on liability for the company’s liabilities in order for the supplier to agree to supply the company where it would not have done so without that guarantee.
For this reason, guarantees are often given in the form of a deed, which will be valid even if there is no consideration given. This also means that the limitation period – i.e. the period after which a claim becomes “time-barred” and can no longer be pursued – is 12 years, rather than the usual 6 year contractual limitation period.
A guarantee which is in the supplier’s standard form (i.e. which has not been negotiated as a bespoke agreement) will be subject to a test of reasonableness under the Unfair Contract Terms Act 1977.
However, previous cases about the enforceability of guarantees have shown that courts will often find that contracts of guarantee will not be regarded as unreasonable when they have been given as part of a commercial relationship by an experienced business person, even if given in standard form with no negotiation between the parties.
Can the guarantee be avoided?
Like any other contract, the starting point should be to consider carefully exactly what the parties have agreed. On a proper analysis, does the guarantee actually cover the circumstances and claims which have arisen? If it does not, the guarantor’s liability will not arise (or could be reduced in scope), even if the guarantee itself is valid.
In certain circumstances, a guarantor’s obligations can be inadvertently discharged. For example, if changes are made to the underlying agreement without the guarantor’s consent, the guarantee can become unenforceable. Possible examples would include the creditor offering an extension to the debtor of the time to pay, or an increase in the sum of the debt owed by the debtor, beyond what the guarantor had agreed to guarantee.
It should be noted though that a well-drafted guarantee will usually contain an express provision allowing for such variation, without it having the effect of discharging the guarantee.
If the guarantor was induced to enter into the guarantee by duress or undue influence, that would also provide a basis to argue that it should be set aside. This is one of the reasons why lenders will insist that a guarantor obtains legal advice on the nature and effect of the guarantee before it will accept it.
A guarantee might potentially also be unenforceable in circumstances where a misrepresentation has been made to the guarantor, and so the guarantee was provided on a false (or misleading) premise. Whilst a lender is not under any general positive duty to disclose information to a prospective guarantor, circumstances can arise where the lender has a duty to disclose unusual facts not known to the guarantor.
Given the potentially onerous nature of guarantees, courts generally adopt a strict approach to interpreting the words used in them. If there is any ambiguity in the way the guarantee has been drafted, or whether it operates to make the guarantor liable in a given set of circumstances, the benefit of any doubt is likely to be given to the guarantor.
This is especially the case where the guarantee is in the lender’s standard form and is an example of the contra proferentem principle of interpretation, where any uncertainty or ambiguity is interpreted against the party that drafted it.
Confused??? Don’t worry we can help
Butcher & Barlow have a team of dispute resolution experts with considerable experience of dealing with claims under guarantees.
If you are a director who has been asked to pay liabilities of a company which cannot meet them, get in touch and we will be happy to review and advise on whether there is any basis to challenge the validity of the claim.
The earlier you take advice, the less time and money the lender will have already incurred in chasing unpaid money and the greater the prospect of being able to negotiate a more favourable outcome, or even avoid liability all together.
Mark can be contacted at mturner@butcher-barlow.co.uk or by telephone on 01606 334309.