Dealing with funding for your company can have a resounding impact that extends beyond your business life and into your personal life. With so much at stake, it is important to understand and prepare for any scenario – that is why we are sharing our business expertise and providing explanations of some of the essentials of corporate finance law.
When a borrower is granted a loan from a bank, the bank will often want security for the loan it makes.
If a bank takes security over the owner of an asset, it means that if the borrower becomes insolvent the bank can take possession of that asset, sell it and use the proceeds to repay the loan. This gives the bank priority for repayment should a company become insolvent, and so puts the bank in a stronger position than creditors who do not have security.
This is because, on the insolvency of a company, any monies that become available for creditors are distributed in a set order:
When a bank loans any kind of money (including an overdraft or credit card facility) to a company, it will want to take either:
In corporate finance law, a Debenture is a written agreement between the bank (as Lender) and the company (as Borrower), which usually combines both fixed and floating charges into one document.
This means that the lender will have security for its loan, safe in the knowledge that all the borrower’s key assets (apart from stock in trade) are subject to a fixed charge. In the meantime, the company is free to carry on its normal day-to-day business and can sell its stock in trade in the ordinary course of business, without having to obtain the bank’s consent for every sale it makes.
The bank will normally require a Debenture to be signed early on in its relationship with the company, and at latest before it loans the company any money or provides any other source of finance.
Once signed, a Debenture is then filed at Companies House. This will notify any other potential lenders that the first lender has priority over the company.
It is important to note that a Debenture can include a charge not only over the assets that the business own now, but also a charge over any assets the company acquires in the future. If this is the case, any new assets that the company acquires will be caught under the Debenture – even if the bank has no knowledge of them.
A Debenture will also contain a Negative Pledge by the Borrower that it will not permit any further security in favour of any other lender over any of its assets. It is important to remember this, as it means that according to corporate finance law, the company would require the bank’s permission to enter into any financing arrangements with a new lender. This is because the new lender will almost certainly want its own security over the company. In this case, the first lender and the new lender may then need to enter into a Deed of Priority (or Intercreditor) to control the relationship between them; the company will usually also be required to be a party to this agreement.
If the Debenture contains a Negative Pledge and the company allows further security without consent from the first lender, the company will almost certainly be in breach of the agreement. This will allow the bank certain rights, including the option to enforce its security against the company.
For example, a Debenture will normally give the bank step in rights. This means that if the bank believes that it has justification – particularly if it judges that its position is deteriorating, e.g. if the company is in trouble or it allows further security in favour of a new lender – then corporate finance law grants power to appoint a Receiver who can enter the business and take control of the assets. The bank can use the proceeds to reduce the debt owed, in preference to any other creditors. This is often referred to as when a charge is crystallised.
It is critical, therefore, check whether your company has any existing security registered against it at Companies House BEFORE you sign up to a Debenture. If it does, then this security MUST either be lifted (only if the first lender has been fully repaid), or consent must be obtained from the existing secured party.
As part of the documentation for any financing arrangements with a bank, the bank may also ask you to personally guarantee the loan or another source of credit. A Personal Guarantee will put you into a direct relationship with the bank, who are then permitted by corporate finance law to pursue you personally if your business becomes insolvent.
Requests for Personal Guarantees by banks are becoming more and more common, but before you agree to become a personal guarantor you should be aware of legal basics, prospects and consequences of such a guarantee being enforced. In any event, the bank will also require that you take independent legal advice on any personal guarantee – that way, you cannot claim that you do not understand and are not bound by it.
When you provide a Personal Guarantee to a bank or other lender, you agree to act as guarantor for the debt obligations of your business. That means if your company defaults on a loan repayment, you have guaranteed that you will pay instead. So, giving this guarantee means that you as a business owner or director will be held personally liable if the business gets into trouble.
As the primary relationship is between the borrower and the lender, if your company doesn’t have any repayments due then you cannot be liable for anything. Your obligation is secondary to that of the business, so a Personal Guarantee will only come into play if your business is in trouble and fails to repay its debts.
Personal Guarantees can come in various shapes and sizes. For example, the lender may ask you to guarantee the full amount borrowed, or a limited sum only. It is important to remember that even where the guarantee is for a limited sum, there may also be bank charges and fees added to this, such as the costs of enforcing the guarantee, and you will still remain liable for all the monies owed by the company/business to the bank. In other words, if you make such a commitment without involving a party experienced in corporate finance law, you could end up being personally liable for more than you think.
A Personal Guarantee will not be enforceable unless it is in writing and signed by the guarantor. Personal Guarantees are generally deeds (i.e. signed by you in front of a witnesses and formally delivered) and are normally treated as unconditional. Challenging a Personal Guarantee will be very difficult, and usually the only way you can get out of one is if the bank releases you.
It is important to remember that a Personal Guarantee is a personal commitment, and this can lead to long-lasting personal financial consequences and, potentially, bankruptcy. If you bank personally with the lender, the guarantee may also contain terms that permit the lender to offset any money you have in a personal account against the debts of the company/business. In a worst-case scenario, this could lead to you losing all of your personal assets, including your cash and your home; you should always take independent legal advice before entering into a Personal Guarantee of any kind.
As we have discussed, there is much at stake in corporate finance law, and you want to ensure matters are handled by the experts. Should you require legal advice assistance in securing finances for your company, our Corporate team are happy to receive your enquiry. If you would like an initial ‘no fee’ discussion with our experienced solicitors, contact the team directly:
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