What are the risks to a director’s personal guarantee when a business enters a Company Voluntary Arrangement?

Directors, quite rightly, view a Company Voluntary Arrangement (CVA) as a panacea for their company’s financial problems. After all, a CVA is a contractual agreement between the ailing company and its creditors under which the creditors are paid their debts over a period of time by the company, albeit usually not in their entirety. A CVA is a rescue procedure for the company which enables it to continue trading and ringfence its historical debts.

However, even though the CVA may be accepted by the company creditors and may also be “fit, fair and feasible”, it may not signify the end of the financial difficulties for those directors who have personally guaranteed the company’s debts.

The risks of personal guarantees

The scenario is all too common and continues to be played out with alarming regularity. A company is struggling financially, notwithstanding a good order pipeline and some good debtors; it simply needs a cash injection in order to right itself. The director may have no desire for, or anticipation that, the company will ever go into insolvent liquidation. Therefore (and of course, under pressure from the lender), the director personally guarantees the debts which it is expected will be paid by the company in a timely manner. Effectively that should be the end of the story, and the company will continue to trade and pay back the lender.

However, what if the borrowings do not have the desired effect and the company needs something more formal to protect itself from aggressive creditors? The company may then enter into a CVA. The Nominee (together with the director) drafts a CVA proposal which shows how the CVA will produce a better outcome for the creditors (and indeed everyone else) than an insolvent liquidation. The CVA is accepted and approved by the creditors, and the company can trade on, thereby saving jobs and protecting landlords whilst paying the CVA creditors their monies. Indeed, maybe those debts will eventually be paid in full and those creditors thus protected.

However, notwithstanding the approval of the CVA, a creditor (PG creditor) who has the benefit of a personal guarantee (PG) from the director often seeks to enforce a PG against the director outside the CVA. This is usually through bankruptcy proceedings which, if successful, result in the financial death knell of the director and probably the company.

Why should such a PG creditor attempt to enforce the PG against the director when they are participating in the CVA? The PG creditor may not believe in the reliability of CVAs and may have seen many CVAs fail in the past.

Maybe the PG creditor does not want its cash flow interrupted, especially as it may have to wait a period of time whilst HMRC is paid its preferential debt by the company.

Maybe the director has lost credibility with the PG creditor by borrowing money at a time when the company was on the verge of an insolvent situation, or maybe the director has not cooperated/communicated with the PG creditor.

How can a director manage a personal guarantee after a CVA?

After checking whether there are any defences to the PG based on the validity and construction, what alternatives does the director have to deal with this?

• Should the director try appealing to the PG creditor’s better nature and that PG creditor’s desire to protect their reputation by adhering to the CVA and thereby saving the company, the directors and employees? Maybe a bit of a long shot. Do reputational issues even exist now?
• What about the director paying something to the PG creditor in addition to the monthly premium by the company under the CVA? That would ensure the PG creditor would have some repayment, especially in the early days of the CVA.
• If, for example, the CVA provides that the creditors will receive 50% of their debt under the CVA, what about the director offering to top up that percentage personally?
• Or if possible, what about the director offering the PG creditor a charge over the director’s property/properties, however unpalatable that may be?

Whatever a director is going to do on receipt of a demand by a PG creditor, it must be done speedily. The director should engage with the PG creditor substantively and offer an acceptable alternative to ensure that some payment is made quickly in settlement of the company’s debt before the PG creditor takes unilateral action.

If you are a director and have questions about personal guarantees and/or CVAs, please contact Tony Sampson.