Securing a bank loan to forge ahead with grand property development schemes has been tougher in the post financial crisis world. One element of borrowing that has continued to thrive though is the banks’ insistence upon personal guarantees from directors.
Personal guarantees in relation to business debts are common and it is often the case that those debts are repayable on demand. This can leave business owners and directors personally exposed to a considerable degree of financial uncertainty. However, under normal circumstances personal guarantees are only likely to be called upon by creditors if a default event occurs such as missing an interest payment.
As with any form of contractual obligation, personal guarantees are open to challenge in certain circumstances. If there has been a misrepresentation for example, they may be unenforceable.
A Ghost from the Financial Crisis
An interesting Scottish case that concluded in 2013 provided a good example of how personal guarantees can be undone by poor procedures and sloppy practices. The litigation involved of the media’s favourite financial crisis whipping posts, Royal Bank of Scotland (RBS), and it was noted by Lord Malcolm in the Court of Session that, “As a case study of the causes and consequences of the property crash in 2008, this litigation is probably as good as any.”
In Royal Bank of Scotland v James O’Donnell and Ian Mcdonald  the defendants had taken out a loan with RBS through their company Winhill Developments Limited in September 2007. The company had been created to purchase a site with a view to securing planning permission and selling it on at a profit. The original valuation of the property was set at £3m. RBS loaned the company £1.65m for one year and the property was purchased for around £1.5m. RBS took charges over the company.
When the time came to repay the original loan in September 2008, the company was unable to do so and RBS agreed to refinance the loan with £1,695m repayable in March 2011. At that time RBS required a 70 per cent loan to value ratio so RBS confirmed a reduced valuation of £2m and obtained personal guarantees of £300,000 in total from the directors to make up the equity shortfall.
When Winhill Developments defaulted in 2009, RBS took control of the property and eventually sold it off for £65,000 in 2010. RBS then sought to enforce the personal guarantees.
Misrepresentations and Duty of Care
The key flaw in RBS claim against the directors under the personal guarantees related to the surveyor’s valuation of £2m it relied upon for the refinancing. That valuation was not seen by the directors at the time of the refinancing and, although they were reassured by RBS that it could be relied upon, it in fact stated that it was only indicative and should not be relied upon for lending purposes.
In his Opinion in the Court of Session, Lord Malcolm held that RBS’s statements to the directors regarding the revaluation in 2008 were misrepresentations and that the personal guarantees would not have been given if the directors had known that the valuation could not be relied upon.
RBS not only failed to recover hundreds of thousands of pounds under the guarantees but it also incurred damages for its breach of duty of care.