Lenders have been warned of the challenges involved with personal guarantees, as a predicted increase in corporate failures brings recoverability into focus.
Business advisory firm Duff & Phelps said that the value and importance of personal guarantees now needs to be assessed carefully by lenders, who will be looking to shield themselves from risk amid rising default rates.
“Over the past decade banks, other asset-based lenders and the growing peer-to-peer providers have increasingly required personal guarantees from borrowers,” said Joanne Wright, managing director, global restructuring advisory at Duff & Phelps.
“This was particularly prevalent with small and medium-sized enterprise borrowers. For the lender this was an important fall-back recovery option in the case of default.”
A personal guarantee is given by an individual rather than a business, which can be highly attractive for lenders when the guarantor has enough assets to cover any exposure, Wright added.
If there are assets then there is no need to wait for the formal insolvency of the business to pursue a guarantor, there just needs to have been a default by the principal borrower. Recovery action can be taken against the guarantor as soon as the default occurs.
“Effective due diligence on the guarantor at the point of providing finance to the principal borrower may have identified assets that have since been transferred or are in the process of being removed,” said Wright. “Therefore, a freezing order maybe appropriate or bankruptcy proceedings against the guarantor to deploy the extensive powers of a Trustee in Bankruptcy.”
Purbeck Personal Guarantee Insurance found that the average value of a personal guarantee-backed CBILS loan was £766,000. This means that – after the government has covered its 80 per cent share of the loan – the borrower could be personally liable to cover an average of £153,200 if the business fails.