Directors should think before waiving limited liability

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published 14 January 2024

Small businesses planning for 2024 may be hoping to borrow to fund their strategies for growth and expansion. But overly cautious banks are too often demanding personal guarantees from the directors of companies arranging finance, warns the Federation of Small Businesses (FSB). It has filed a “super-complaint” with the Financial Conduct Authority (FCA), the City regulator, asking it to investigate such practices.

The FSB is particularly concerned that banks are targeting directors of limited liability companies, where directors are largely protected from personal liability for debts incurred by their firms. When a bank demands a personal guarantee from the directors, this undermines the protection that the limited-liability structure is supposed to provide. Some businesses may decide this is a risk they don’t want to take, hampering their ability to grow. Others may go ahead, putting the directors in a vulnerable position.

The FCA will respond to the complaint in the coming months. But in the meantime, should small-business directors ever provide a personal guarantee in return for bank finance?

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There isn’t a right or wrong answer to this question, but it is vital that you do not sign up for such arrangements without understanding all the implications, including the fine print of the financing. In practice, this makes it important to seek independent legal advice on the loan contract.

Above all, you must recognize that by signing up for a personal guarantee, you are promising the lender that you will take responsibility for the debt of the business if it can’t pay what it owes. That gives the lender the right to come after your assets – typically without a court order – if the business defaults. Those assets could even include your home. Moreover, if you don’t have sufficient assets to repay the loan in full, you could face bankruptcy and disqualification from serving as a director for a period. Even if you can cover the losses, your personal credit rating will be adversely affected, with potential consequences for the rest of your family finances.

If you do decide to accept a personal guarantee, study the terms carefully. For example:

Under what circumstances can the lender call the guarantee in?
How does it define a default on the debt?
Are you required to indemnify the lender against additional costs?
How will defaults be enforced, and what assets could the lender demand from you?
What rights does the lender have to demand immediate repayment of its loan?

In an ideal world, you may be able to avoid these difficulties by offering company security in return for finance, rather than your personal assets. If not, your legal team may be able to secure some protection – a limit on your personal liability, for example, or a commitment that calls will only be made on the guarantee as a last resort. The question of how liability will be shared by several directors should also be assessed.

Finally, it may be worth considering personal-guarantee insurance. This cover, available from specialist small-business brokers and insurers, pays out to help directors repay the company’s debt without having to give up their own assets. It effectively underwrites the personal guarantee you’re being asked to provide.

This cover can prove very valuable, particularly if your business suffers something completely unexpected that causes it difficulties. However, the premiums can be expensive, particularly for firms with weaker finances.

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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.