“It’s Not Personal, It’s Strictly Business”: Personal Guarantees in the Context of Loans

When a personal guarantee is given in respect of a loan and the terms of the loan are later changed, this may cause problems for the lender if it seeks to enforce the guarantee. In the article below, Henry Evans, a solicitor at Gordon Dadds, will explore the law on this, as well as a recent High Court case which has provided welcome clarification.

Commercial background

A personal guarantee (often referred to as a ‘PG’) is a promise made by an individual to fulfil the obligations of a third party if the third party fails to fulfil its obligations. Often, directors of a company will personally guarantee monies borrowed by that company from a bank, so that if the borrower does not repay the bank, the bank will be able to claim the monies owed from the directors instead.

Personal guarantees will often contain a cap, so that the person granting the guarantee (known as a ‘guarantor’) will only have to repay up to a certain amount of the total monies owed. From a lender’s perspective, even where the amount borrowed by a company is far more than the directors could possibly repay in reality, it is often considered to be worth getting personal guarantees from the directors on the basis that doing so will help to focus the directors’ minds (since the directors’ own assets will be at risk) and ensure that they take the repayment of the loan seriously.

Legal background

From time to time, it may be necessary or desirable to change the terms of a loan and the relevant documentation. For example, if the borrower suspects that it will be unable to repay the borrowed money on time and the bank is willing to let the borrower have extra time to pay, the facility agreement will need to be amended to push back the repayment date; if the borrower needs to borrow more money than was originally made available, the facility agreement will need to be amended to increase the commitment. It is very common in practice for facility agreements to be amended.

Making changes to a facility agreement without the consent of any guarantors who are guaranteeing the monies lent under the agreement can lead to the guarantees being rendered ineffective. The judgment in the case of Holme v Brunskill [1878] shows that if a guaranteed contract is substantially amended without the consent of the guarantors, the guarantors will be released from their guarantees. Minor amendments, or amendments which do not adversely affect the guarantors, will not discharge the guarantees. It is worth noting that an amendment to increase the loan being made available to the borrower is likely to be found to adversely affect a guarantor even if the guarantor’s liability under the guarantee is capped, as the increased loan sum is likely to mean that the borrower is more likely to be unable to repay the loan, and therefore there is a higher risk that the guarantor will be required to make a payment under the guarantee.

As a result of this, a provision is usually included in guarantee documentation to state that the obligations of the primary debtor may be changed in future without the need for the consent of the guarantor (this is known as an “indulgence clause”). Such provisions can work, but case law, including Triodos Bank NV v Dobbs [2005], shows that an agreement that an indulgence clause will only be found by the courts to cover amendments which fall within the purview of the original guarantee. This means that some variations are so substantial that an indulgence clause will be ineffective. In Dobbs, both the amount of the loan and the scope of the development to be financed by the loan were substantially increased, and this was found to be outside of the purview of the original guarantee and so the guarantee in that case was found to be ineffective.

Recent case – facts

Maxted v Investec Bank Plc [2017] concerned loans made by Investec to three Luxembourg companies under three separate facility agreements, so that the borrowers could purchase real estate in Germany. The two directors (who were also the owners and managers) of the borrower companies gave personal guarantees to the bank, with a cap on the total amount that the directors would have to pay if the guarantees were to be enforced. The guarantees each contained a (standard) indulgence clause stating that the guarantee would not be rendered ineffective by any variation or amendment of any agreement between Investec and the borrowers.

The facility agreements were amended more than once to extend the term of the loans and to roll up the interest. Both directors signed a statement on the last occasion when the facility agreements were amended to confirm that Investec could continue to rely on the personal guarantees and stating that they waived their right to seek independent legal advice in respect of the personal guarantees.

The borrower companies failed to make the payments under the loans, so Investec made demands against the guarantors in respect of the personal guarantees. The guarantors refused to pay, arguing that the personal guarantees had been discharged as a result of substantial amendments to the facility agreements (which the guarantors argued were outside the scope of the indulgence clause in the personal guarantees).

The guarantors claimed that they could not recall being consulted about the amendments to the facility agreements and that they had not received any advice in relation to their role as guarantors (they stated that banking affairs of the borrower companies had been dealt with by a business partner who had since died, though both of the guarantors had executed the banking documents). The guarantors also argued that they had been subject to undue influence when it came to their signing the waiver of their right to seek independent legal advice, on the basis that a relationship of trust and confidence existed between Investec and the guarantors.

Recent case – judgment

The High Court held that, on the facts, the changes to the facility agreements (extending the term of the loan and rolling up the interest) were within the scope of the indulgence clause in the guarantee. With regard to the guarantors’ claim that they had not consented to the amendments and received no advice in their capacity as guarantors, the Court found that it would be “unreal” to divide the guarantors’ knowledge between that which they had gained in their capacity as directors, owners and managers of the borrower companies and that which they had in their capacity as guarantors. The fact that they knew all about the amendments in their capacity as directors meant that they were also held to have had this knowledge in their capacity as guarantors; the judgment states that “in any event, the evidence supports the view that there was consent to the variations”, though this was not decisive in the case since the amendments were within the scope of the indulgence clause.

The Court also found that there was no evidence at all that Investec had influenced the guarantors to execute the personal guarantees and that even had there been such evidence there was no evidence to support the contention that any such influence was undue. The relationship between Investec and the guarantors was held to be commercial and that the guarantors were “men of business” who understood the risks of granting personal guarantees, so undue influence was not relevant.

Comment

This judgment will please lenders since a market standard indulgence clause, on the facts of the case, was found to have given sufficient latitude for the repayment date of a loan to be extended and interest to be rolled up. Both of these amendments are commonly made to facility agreements in practice. This means that the clause operated exactly as it was intended in respect of these amendments. The case is also helpful in confirming that the courts will not necessarily distinguish between information held by individuals in their roles as directors of a borrower and that held in their roles as guarantors of that borrower.

That said, lenders and their advisors should be careful when making amendments to loans, and may wish to think about the following in order to minimise the risk of a court finding that a guarantee has been discharged:

• A lender will want to consider gaining guarantors’ consent for any amendments to a facility agreement which may adversely affect the guarantors. The lender will also wish to consider requiring the guarantors to enter into a deed of confirmation in which they state that the guarantees will continue to apply in respect of the amended facility agreement. This approach may not always be practical.
• A lender may consider requiring the guarantor to give an “all monies” guarantee – this is a guarantee which covers all monies owning from the debtor at any time and is not limited to monies owing under a particular agreement. The courts have confirmed that such a guarantee will cover all sums owed, regardless of variations made to loan agreements. Of course, this is a commercial point and it may be that a guarantor will not be prepared to grant an all monies guarantee.
• A lender may also require a borrower to grant an indemnity as well as a guarantee. A guarantee is a secondary obligation, meaning that it is a commitment to do something only if the principal debtor does not do it; an indemnity is itself a primary obligation, meaning that it is not affected by the position of the principal debtor. Therefore, while a guarantee may be discharged as a result of the variation of a loan agreement with the principal debtor, the lender ought still to be able to rely on an indemnity. It is common practice, when drafting guarantees, to include indemnity wording in the same document, so that a bank is granted both a guarantee and an indemnity.

Directors of companies which are borrowing money should always be mindful of the risks of entering into personal guarantees. Anybody entering into a personal guarantee should be aware that they are putting their personal assets (potentially including any houses, saving and investments that they own) at risk and should not enter into such an agreement without considering the potential consequences and seeking appropriate legal advice upon it.