Are you a Company Director? Could you have given a personal guarantee perhaps without realising?

Parties who lend or advance funds, goods or credit expect to be repaid. There are number of tools available to them to do that – they can sue for payment or use other means to enforce payment. Often though, lenders will request, before lending, that a third party, such as a director or majority shareholder, give a personal guarantee ("PG") which can relied upon in the event the borrower fails to make payment of the sums owed.

In the construction industry trade accounts are very common. One key example is the trade account which contractors will have with material suppliers. The supplier will supply building materials in advance in the expectation that the contractor will settle the account at some later stage. There will be a contract in place for the supply with the contractor in the form of a trade account agreement. We are seeing circumstances where material suppliers are also asking for PGs.

What is a PG?

A PG is a legal commitment where a third party, known as the guarantor, agrees to take on the responsibility for the debt or obligations of the primary obligant (i.e. the borrower) in the event that the borrower fails to fulfil their commitments. This arrangement provides an added layer of security for the lender, as it ensures that even if the borrower defaults, the guarantor will be obliged to step in and pay the debt due.

Guarantees are commonly used in a range of financial transactions, including loans, leases, and credit agreements. They are particularly prevalent in cases where the borrower may present a higher risk of default; perhaps because they operate in a particularly volatile market or where the borrower's credit history may be less than ideal. In construction terms, there is an element of this coupled with the often high – or ever changing – value of the materials being advanced.

For lenders, a guarantee reduces the risk associated with lending, making them more likely to extend credit or offer more favourable terms to borrowers. However, for guarantors, this commitment carries significant responsibility and potential financial liability, as they are legally obligated to cover the debt if the borrower fails to do so.

In essence, a PG functions as a safety net for lenders, ensuring that their financial interests are protected even in the face of borrower default. This practice underscores the importance of guarantees in maintaining confidence and stability in lending and financial transactions, particularly in uncertain economic times or sector challenges. The construction industry is still enduring the fallout from the latest economic crisis from the perfect storm of Brexit, COVID-19, the war in Ukraine and recent UK political decisions. The number of insolvencies in the sector have increased and naturally lenders want to protect their interests.

Cautionary tale

In the recent case of Screwfix Direct Ltd T/A Trade UK v Mr James AKA Jamie Paterson [2024] SC HAM 1 a supplier of building materials ("Screwfix"), sought payment for materials supplied to Paterson Restoration Limited (the "Company") in 2019 and 2020. The Company was wound up in March 2020 owing money to Screwfix for the materials. Screwfix claimed that Mr Paterson - a director and shareholder of the Company - was personally liable for the Company’s debts under a personal guarantee contained within a Trade Account Card Agreement.

The key legal issue was whether a clause in the Trade Account Card Agreement constituted a PG by Mr Paterson. The clause stated:

“I, the director, agree to guarantee performance of all the company’s current and future financial obligations to Trade UK, including any subsequent increase/s in credit limit”.

In the Trade Account Agreement, Mr Paterson is named as “DIRECTOR”. He signed the agreement. The agreement states that in the case of limited company “the form must be signed by a director”.

Screwfix argued that this clause was clear and imposed personal liability on Mr Paterson for the Company's trade debt. Mr Paterson defended the action and contended that he signed only on behalf of the Company, and not personally. Therefore, he was not personally liable for the Company's debt under the Trade Account.

The court found that the clause was intended to secure a PG. The language was sufficiently clear to impose such a liability. Other clauses within the agreement reinforced this position; including "You are authorised to bind the account holder to this agreement by signing it." The court found that the term of the agreement only made sense if construed as a personal obligation on Mr Paterson; it was directed towards his capacity as an individual.

In short, the agreement required to be signed by a director who was also to give a PG. Any other interpretation would make the clause redundant. Mr Paterson was held to be personally liable for the debt owed by the Company to Screwfix.

Read the small print

PGs are typically sought at the outset when parties have a good relationship. They are then put in a drawer and forgotten about and, unfortunately, only considered when the business fails or falters. For those who have given the PG, they may have had to deal with the emotional and financial cost of the failure of their business, and on top of that they personally get a demand on the PG. This can feel like a double whammy.

This decision is a helpful reminder to those who are responsible for placing orders and setting up credit or trade accounts to read the small print.

All too often directors are unaware that they are personally responsible for a company's debts as they do not fully appreciate the effect of the document that they were signing.

Prevention is better than cure: if you do see a term that you are not sure about in a financial agreement – or indeed any contract - that you are being asked to sign, then ask for it to be removed or take advice on the impact of the clause on you before you enter into the contract. Failing to do so could be an expensive mistake.