Let’s start by explaining what a ‘PG’ is and isn’t. A PG is most often asked for when a Company is seeking a loan from a bank and the bank seeks to tie in the Directors personally, it is basically an undertaking that if the company cannot pay back the loan then the Directors will do it themselves. This does of course serve to undermine the concept of a ‘Limited Liability Company’.
It’s a straightforward legal document and simple security for a lender (or an investor) to take, usually involving a solicitor independently explaining the commitment and witnessing the signature.
Some technical things to explain:
- PG’s can be limited by amount (usually the amount of the loan) or unlimited (quite rare now for a lender to ask for this and for someone to be prepared to give it of course)
- A ‘Joint and Several’ Guarantee is where there might be more than one Director giving the Guarantee and in that case the bank will ask for each to guarantee the whole amount, rather than perhaps logically their ‘relative share’ of the liability. This is simply to give the bank the option of pursuing any of them for recovery of the money.
- A ‘Third Party’ Guarantee is where someone who is not directly connected with the borrower is providing the guarantee. This is quite rare now – it used to be common, say, for a parent to guarantee the liabilities of a family member. However, it could apply where a High Net Worth individual is the ‘ultimate beneficial owner’ of a company but is not registered as a shareholder or Director.
- A ‘Supported’ Guarantee is one where the guarantor adds a legal charge over personal assets to bolster the value of the guarantee. So, it could be a charge over the Directors matrimonial home.
Lender’s policies with PG’s have generally been shaped over the years by the outcome of Court cases they have lost when trying to pursue a guarantor. So, third party guarantees are rarely any good to a lender because it is too easy for the guarantor to claim that they were signed under duress or they were not fully aware of the facts. Similarly taking supporting security over a matrimonial home causes the banks anxiety where a spouse could claim that an asset that they have rights over has been used as security against their wishes.
So why do lenders ask for PG’s?
Often a lender will ask for this form of security not because of the its value but due to the commitment it brings. The argument is that if things get tough for the company the directors are less likely to ‘walk away’ from the situation. This particularly applies to property developments.
So why have PG’s become more common?
The answer is a combination of factors:
- Bankers are very aware of how easy it is now for a Director to ‘collapse’ a company if things go badly.
- Tough trading times over the last decade have left company balance sheets with less ‘fat’ that the bank can rely on for direct security. Many SME’s are doing OK but are not sitting on reserves of cash or surplus/undervalued assets.
- Buy-to-Let regulatory changes have let to a wave of professional landlords shifting the ownership of their properties into Limited Companies, where the tax treatment is more favorable. That however is leading to many of them facing requests for PG’s from B2L lenders who before could have relied upon their direct personal liability.
- In the same way that nature abhors a vacuum, a host of new lenders have filled the gap in funding for SME’s, mainly new platforms, peer to peer or fintech businesses. These lenders very rarely meet the directors making on-line applications and instead rely on algorithms and risk scoring systems to evaluate a business loan. That light-touch form of underwriting needs to be bolstered by a PG. Some might call that lazy underwriting, but it is lower cost.
So, is there a problem looming?
There are some problems for lenders here, namely:
- Unlike other forms of security (such as Mortgage Debentures) there is no ‘register’ of PG’s. A lender who believes that a Director has a certain net worth behind their PG has no idea whether they have already committed themselves with PG’s to a host of other lenders or suppliers. Some active/HNW Directors may not even keep their own record of PG’s they’ve signed.
- If several PG’s have been given, and things go wrong, one PG doesn’t necessarily get priority over another. Who decides which lender gets paid first?
- Guarantors are usually first asked to complete an ‘Asset & Liability Statement’. When completing these forms, it is easy to remember (and for the bank to check) the assets side and their values. On the liabilities it is easy for someone to genuinely forget that they provided a PG a few years ago, say for the purchase of company assets on finance, and to know the current liability. It is also difficult for the bank to validate the figures.
For Guarantors it is possible to take out insurance policies to cover any future claims, and perhaps more should, or the banks should insist on it? Much as they used to insist on life cover for borrowers.
It is unfortunately a fact that if a Director was adamant that they were not going to sign a PG then their chances of raising finance would be limited.
However, it is possible to build a case for a lender to lend to a company on a ‘stand-alone’ basis if the raw materials are there. Don’t however expect there to be a plethora of lenders willing to do it though and do expect the ‘pricing for risk’ to increase the interest rate.