Written by Helen Young, Associate in the Commercial Litigation & Dispute Resolution Team at SA Law
In a recent court case, a festival director was sued for and cleared of failing to fully pay back a £1m personal loan, with the judge ruling he wasn’t personally liable for the funds.
Bestival director Robert Gorham, otherwise known (some might say ironically) as DJ Rob Da Bank, was sued for a total sum of £650,000, which TicketLine alleged it had lent to him in a last-ditch attempt to save the festival. While Gorham was lucky, other directors thinking to take out a personal loan to then plough the funds into a limited company should practice caution – as should those who advise them – and be mindful of the legal pitfalls at play. So, what needs to be considered?
We should firstly draw our attention to the different ways a business can borrow money. When a company borrows money and can’t pay it back, the lenders become unsecured creditors. So, lenders typically look to secure money lent against an asset owned by the company, such as a building or machinery. But it’s different for smaller businesses and start-ups which don’t own such assets: when money is borrowed by a limited company, it is liable to the lender– including in cases where that company ends up in administration or liquidation.
As a result, lenders frequently refuse to lend to limited companies if there’s no security or guarantor, and instead require personal guarantees from directors which can be called on if the company in question is unable to pay the loan back, or becomes insolvent. In such cases, the guarantees enable the lender to pursue the directors (and their assets) in their personal capacity. Meanwhile, directors may opt to borrow money personally, and – as argued by TicketLine – lenders may also feel this is a safer option.
Regardless of how the money is borrowed, a written record is a must: if you do not have it in writing, there will be disputes over who is liable to repay the money and when. This was the problem in Gorham’s case: there were not adequate records showing the money TicketLine gave him was indeed a loan which he’d agreed to pay back.
In addition, any guarantees related to the loan must also be in writing and clearly identify exactly what the guarantor is guaranteeing, as well as the case in which their liability is triggered. Otherwise, a lender could claim that the director in question gave an ‘all monies’ guarantee, when really they had only intended to guarantee a specific sum, not realising the extent of the debt they could be required to pay back.
The fact that Gorham wasn’t liable for repayments shouldn’t encourage financial advisors to advise directors to take out personal loans, though, as it can contravene a director’s statutory duties and shareholders’ agreements. Directors’ statutory duties require them to promote the success of the company, as well as administer a certain level of skill and care, which includes ensuring that the terms of a loan are reasonable in the circumstances.
Directors are also required to be mindful and – in the case that they know the company will or likely will become insolvent – act in the best interest of the company’s creditors. This can be tricky, and financial advisors should be on hand to steer directors in the direction of loans with the best terms which protect their positions and prevent them being personally liable for a breach of duty.
In summary, when directors borrow in their own name because the company can’t raise the funds to do so, they are taking a big risk – financial advisors ’s must always be mindful of this. It’s imperative that records of the terms on which the loan will be repaid by the company are made, as well as the injection of the borrowed money and any repayments. Also, protocols for a transaction between a director and the company must be followed (to prevent repayments being challenged/recovered).