Moving the loan goal posts: was a personal guarantee shown the red card?

Most lenders require corporate borrowers to provide security for a loan to protect their position should that borrower default under their loan transaction.  Lenders want as much “security” as they can get on any given transaction which means that in many cases they will (as a condition to making the loan available) require personal guarantees (PGs) from the directors of a corporate borrower as additional “security” in which the directors guarantee the payment and/or performance of the borrower under the relevant loan transaction.

A PG will put a director’s own assets – e.g. real estate, savings, investments – on the line should the borrower default.  Put another way, the personal guarantor’s liability only kicks in if and when the borrower fails to pay or perform under the loan transaction.  This is a crucial principle of the law of guarantees. It is also why guarantees are commonly referred to as “secondary obligations” because they are dependent on the “primary” one, i.e. the borrower-lender loan transaction.

A consequence of this principle is that a personal guarantor will be discharged from his or her PG obligations if the loan transaction between the borrower and the lender is varied in a material way or in a way which prejudices the personal guarantor after the PG is given.  This is because:

  • the personal guarantor agreed on day 1 to guarantee a particular type of transaction with agreed terms; and
  • any material or prejudicial change to those terms moves the goal posts from their day 1 position to somewhere else on the pitch, thereby altering the day 1 deal to which the personal guarantor signed up.

Loan agreements are amended all the time for various reasons and many of the loans made under them will be guaranteed.  No lender wants to run the risk of losing the benefit of its PGs when a loan agreement is amended.  The most common way to avoid this happening is, you guessed it, to obtain the consent of the personal guarantor to the amendments.

A recent case, Maxted v Investec Bank Plc [2017] EWHC 1997 (Ch), examined whether or not directors were released from their PG obligations when the underlying loan agreements were amended.

Facts

Investec Bank Plc (Investec) made loans to three companies under three separate loan agreements.  Mr Maxted and Mr Lorimer (the owners and directors of these companies) guaranteed the interest payment obligations of these companies under the Investec loan agreements up to a capped amount of EUR 450,000.

The loan agreements were amended at various times to increase the loan amounts, to extend the length of the loans and to provide for capitalisation of accrued interest.  Separately Maxted and Lorimer had also:

  • confirmed that Investec could continue to rely on their respective PGs; and
  • waived their right to seek independent legal advice in relation to their PGs.

The borrowers failed to pay and Investec claimed on the PGs.  Maxted and Lorimer sought to have the claim set aside arguing that:

  1. the loan agreement amendments increased their risk and discharged their obligations under the PGs; and/or
  2. there was undue influence from Investec in relation to the loan agreements amendments.

Maxted and Lorimer failed on both grounds #1 and #2.

Ground #1 failure: consent

They failed on ground #1 because their PGs contained what is known as an “indulgence” clause drafted on customary terms, which stated that “any variation or amendment” of the loan agreements or any “time, indulgence or other concession” granted by Investec would not affect the guarantors’ obligations.  It was held that the loan agreement amendments were changes which fell within the scope of this clause and they did not impose new or different contractual obligations on Maxted and Lorimer nor did they replace the original obligations.  In short, Maxted and Lorimer had, by signing up to the PGs which contained this “indulgence” clause, consented up front to the loan agreement changes.  Maxted and Lorimer also failed on ground #1 because the court concluded that:

  • they consented explicitly to the variations in the independent legal advice waiver letter they had signed; and
  • they were directors of the borrowers and knew about the proposed loan amendments, so it would be “unreal” to divide their knowledge in their capacity as guarantors from their knowledge in their capacity as directors.

Ground #2 failure: undue influence

A PG can also be set aside if the personal guarantor was unduly influenced to enter into it, or to confirm it or to waive his/her right to seek independent legal advice in relation to it.  Maxted and Lorimer failed on ground #2 because:

  • the “indulgence” clause did not create a relationship of confidence and trust between them and Investec;
  • their relationship with Investec was solely commercial; and
  • Maxted and Lorimer were experienced businessmen, capable of looking after themselves and understanding the risks involved in the giving of the PGs.

All of the above meant that there was no undue influence.

Comment

This case should be welcomed by lenders.  Its confirmation that a market standard “indulgence” clause results in a guarantor consenting in advance to particular types of loan agreement amendments is positive and shows that the clause does operate in the way that lenders intend.

That said, lenders should always consider carefully the proposed loan agreement amendments and whether or not they fall within the scope of an “indulgence” clause.  If they are significant and could impose new obligations on a personal guarantor and discharge him/her from his/her guaranteed obligations, then the best (and most common) course of action is to seek a guarantee confirmation.

Conversely, the outcome of the Maxted case contains some “red flags” for personal guarantors.  First, by signing up to a PG which contains a customary “indulgence” clause a personal guarantor will have agreed up front to certain types of loan agreement amendments. Secondly, personal guarantors should always be mindful of giving guarantee confirmations and waiving their right to independent legal advice. Thirdly, Maxted establishes that the separation between individuals in their capacity as directors of a borrower and in their capacity as personal guarantors of that borrower’s debt will not hold water in certain situations (e.g. owner-managed businesses). 

Jonathan Porteous, head of Banking & Finance at Stevens & Bolton, comments: “This case is noteworthy and helpful from a lender’s perspective as it demonstrates the effectiveness of an “indulgence” clause working as lenders intend it to work.  But it really does highlight the risks associated with guarantees for personal guarantors.  PGs are often given by individuals to support their business and it is only natural to be a little bit over-optimistic about the company's prospects. Those giving PGs should always remember that personal assets are at risk and PGs should not be given without a full understanding of the consequences.”

If you have concerns about your position under a PG or have been asked to give or confirm one, please feel free to contact us.

Contact our experts for further advice

Andrew Dodds, Caroline Carmichael

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