Author: Roy Perrott
Guarantees are a common feature of property transactions. Difficult economic times make it more likely that a guarantee will be sought and that it will be called upon. The guarantor will frequently be the parent company or a stronger subsidiary within the group. For small companies, however, often the only guarantor on offer is one of the company’s directors.
The party taking the guarantee needs to tread carefully when a personal guarantee is proffered. If the guarantor can show that he did not know what he was signing, or that pressure was put on him to sign, the guarantee may be unenforceable. The recipient may be unaware that there is anything untoward and yet find that, when it seeks to enforce the guarantee, it is unable to do so.
This is the problem that the landlord faced in the recent High Court case of Trustees of Beardsley Theobald’s Retirement Benefit Scheme v Yardley  EWHC 1380 (QB).
Body Care International Ltd (BCI) needed shop premises in Nottingham. There were concerns about BCI’s covenant strength but the landlord was persuaded to accept a guarantee from the company’s "sales director", Mr Yardley. On this basis, BCI committed to a 15 year-lease at a rent of £32,000 pa, with Mr Yardley guaranteeing its obligations. BCI became insolvent some time afterwards. There was no prospect of recovering from BCI so the landlord sued Mr Yardley for the rent arrears.
Unfortunately for the landlord, the court held that the guarantee was void. Mr Yardley had been duped into signing the lease. He had thought that all he was doing was witnessing the managing director’s signature, something that he had been asked to do many times before. Only the last page of the document was presented to him and he was prevented from reading the rest of it. The contents of the document should have been explained to Mr Yardley and he should have been given the opportunity to take independent legal advice, paid for by BCI.
There was no suggestion that the landlord knew about this, so why was the guarantee unenforceable? It is enough if the recipient ought reasonably to have known that the guarantee was not entered into freely. The court felt that the surrounding circumstances should have alerted the landlord to the fact that something was awry. The landlord was aware that BCI was in financial difficulties. There was confusion about Mr Yardley’s status, the landlord initially being told that Mr Yardley was not a board director and then subsequently being told that he was. The protracted delay in completing the lease should also have aroused the landlord’s suspicions.
The outcome seems harsh. Why should the fact that the tenant was in financial difficulties and that the lease was taking longer than expected to complete have prompted the landlord to question whether the guarantee was being freely given? Many lettings, unfortunately, fall into this category these days. Clearly, the court had sympathy with Mr Yardley’s position. Had the claim against him succeeded, he might have faced bankruptcy. In the circumstances, it was easier to find against a landlord which could have made more enquiries than it did.
The consequence is that any party taking a personal guarantee, not just landlords, needs to be very cautious. Thankfully, it is possible to glean from the judgment some guidance as to what measures the benefiting party should take. First, check that the guarantor is financially sound. This could be done by carrying out a credit check or by asking for a bank reference or accountant’s reference. These days, one can also carry out an online insolvency search against an individual quickly and at no cost.
Secondly, is the guarantor aware of the risks that it is committing to and is it being given the opportunity to take independent legal advice? The court criticised the landlord for failing to obtain a written acknowledgement from the guarantor to this effect, so it is clear that a paper trail is advisable. Ensure that the guarantor is sent an appropriate letter explaining its rights and that it countersigns and returns the letter as proof that it has taken any necessary independent advice.
Some may recognise a similarity between what is being suggested here and the so-called "Etridge" guidelines that apply to residential mortgages. These stem from a series of cases in 2001 in which a wife mortgaged her interest in the family home as security for her husband’s debts. The court set out strict guidelines that a bank would need to follow to ensure that its security was enforceable.
Other options are worth considering. A corporate guarantee is less vulnerable to challenge than a personal guarantee, providing there is sufficient commercial benefit for the company entering into the guarantee. Does there have to be a guarantee at all? Could the individual be made a joint tenant instead, or is some other form of security, such as a rent deposit or bank guarantee, available?
A party seeking to rely on a personal guarantee needs to err on the side of caution. A guarantee is worth nothing if you cannot rely on it. In the current economic climate, where guarantees have taken on even more importance, the safeguards outlined here ought to ensure that, when called upon, the guarantee will be enforceable. Whether the guarantor is good for the money is, of course, another issue entirely.
Roy Perrott, Professional Support Lawyer, Fladgate LLP
This piece first appeared in Estates Gazette on 10 March 2012 and was reproduced with the permission of the publishers of Estates Gazette, Reed Business Information.