Personal Guarantees, ILA and Consumer Duty.

In the realm of business financing, personal guarantees (PGs) are a crucial aspect often required by lenders yet begrudgingly provided by individuals. Rightly perceived as a spanner in the works to the limited liability many shareholders enjoy, the potential personal exposure is often a sticking point in negotiations.

Why Banks Like Personal Guarantees (and Clients Don’t)

Lenders favour personal guarantees, they are relatively cheap and readily available to execute, they play a valuable role in focussing the mind of those ultimately responsible for a company’s obligations and they can outlast some more transient pieces of security.

The stakes however are high and the prospect of personal assets over and above company security as well as potential estates being at risk is quite rightly of concern.

Consumer Duty.

The Financial Conduct Authority (FCA) introduced new guidelines under the Consumer Duty framework in July 2023 requiring firms involved in transactions with Retail clients to take reasonable steps to avoid causing foreseeable harm to customers.

Key to this piece of legislation is that the principles extend beyond lenders, to other entities involved in the supply or manufacture of products and services.

Now the FCA does explicitly state that this does not place responsibility on lenders to prevent consumers from experiencing any bad outcomes. Should a business default on its obligations due to negligent management then that falls outside the scope of the regulations, but it does require advisers to do more.

For firms involved in the provision of Independent Legal Advice (ILA) this regulatory shift necessitates a proactive approach to minimizing client risk.

When Might a Bank Call on a Personal Guarantee?

Contrary to common belief, a lender cannot arbitrarily call on a personal guarantee. Such action typically occurs only when the business cannot meet its obligations. Indeed, circumstances like the death or incapacity of a guarantor might trigger a lenders decision to reconsider it’s position and I would expect some lender contact as a minimum. However, provided obligations within a facility agreement are honoured and can be demonstrably maintained, the continuity of facilities would be more likely.

The vast array of potential shocks which could render obligations untenable are outside the scope of this piece however the most common arise due to challenges with profit, cashflow and ownership.

What can be done?

Considered business planning can mitigate the impact of unforeseen changes in ownership, challenges with cash flow and company profit makers thereby reducing the knock-on effects to debt servicing ability. If guarantors can get comfortable that wider risks are covered then responsibility and concern is refocussed back onto ensuring the business delivers on the assumptions provided to the lender at credit stage as well as providing a workplace that retains key personnel.

The Role of Legal Advisers in Mitigating Foreseeable Harm.

When advising on personal guarantees and providing ILA, it is essential for legal advisers to take a comprehensive approach to risk mitigation. ILA providers must ensure that guarantors are fully informed about the potential implications of PGs, including the risk to personal assets and the impact on their estate planning. The implementation of Consumer Duty now means this process is not merely about explaining the nature of the contract, but also about addressing foreseeable harm.

Legal advisers should work closely with suitably qualified professionals who can identify and mitigate vulnerabilities and wider risk exposures within borrower balance sheets. Examples could include unfunded shareholder agreements or over reliance on individual unprotected profit makers.

One could argue that lenders should be covering this within their credit processes however their primary concern will be that of their own balance sheet alongside risk of financial strain and financial powers of resistance of borrowers. In effect they have outsourced responsibility in terms of the PG by virtue of the independent status of the advice. So, who should be asking these questions?

My view is that both lenders and legal advisers should be aware of the wider scope for foreseeable harm when PGs are being signed and that signposting to professionals who can cover off the risks should be a minimum. Examples of firms where disclaimers are being signed should a client not wish to consider mitigating the wider risks are now frequent. Good practice I would suggest if the regulations capture those also involved in the supply chain.

Whilst as an aside from the focus here I would also expect that in their wider dealings lenders will prefer firms on their panels who are fully briefed on this legislation and what it means for their roles within financial transactions.

Conclusion.

Personal guarantees are a double-edged sword for business owners, they provide lenders with security but expose individuals to significant risks. Proactive planning and adherence to new regulatory frameworks by advisers is essential in mitigating foreseeable harm. By incorporating strategies to mitigate risks around assets, key people and ownership agreements, businesses can protect both their financial stability and the personal assets of their directors and shareholders.

Firms advising on personal guarantees must take a holistic approach, ensuring that all foreseeable risks are addressed to protect both the business and its guarantors. The role of legal advisers in providing ILA is paramount in this process, as it not only fulfils regulatory obligations but also ensures that the interests of all parties, not just clients are safeguarded.

Now, if someone waives their right to ILA as a fully involved director, that is a topic for another day.