Financial institutions, especially banks dealing with small business loans, are often asked for loans by directors of companies that do not have insufficient assets. This places banks in a difficult position because they often want to help their clients but at the same time they can’t take risks with depositors’ money. The result is that banks frequently require directors to give a personal guarantee as security for money borrowed by the company.
If the business is subsequently unable to repay the guaranteed loan then the bank expects to rely on its guarantee. Accordingly guarantors are now asked to seek legal advice before signing a guarantee or at least confirm they have been advised to get advice before signing.
Directors should therefore be mindful of the obligations they may be taking on when seeking business finance and weigh up the pros and cons.
We are, however, aware of clients being told by bank managers that they would never expect to actually call upon the guarantee. This confuses the issue as it begs the question why take a guarantee. However most likely if a guarantee exists, it will normally always be called upon in the event of a default providing the director has sufficient personal assets.
While a bank relationship manager may be uncomfortable asking a client to sign a personal guarantee and often confuse their client by trying to reassure them, the bank’s in-house recovery team won’t have a problem if the a bad debt is passed to them.
Some commentators and many aggrieved directors have tried to turn this into an ethical or moral issue but it is straightforward. Banks need security and they should not be lending money at risk, at least not retail or commercial banks. In turn the reduced risk to the bank should attract a low cost of borrowing to the client.