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Eldwick Law sets out guidance on what personal guarantees are and the grounds upon which you can challenge them.

Personal guarantees and the law

A personal guarantee is an agreement whereby an individual (the guarantor) agrees to satisfy the contractual obligations of another party, in the event that contracting party fails to do so. Generally the guarantee is given in favour of a creditor (such as a bank) and the contractual obligation is the repayment of a sum of money by a particular date.  For example, if an individual signs a personal guarantee on behalf of a business when taking out a loan, the individual is agreeing to become personally responsible for the financial obligations of the business to the bank, in the event the business fails to make its loan repayments.

How far does a guarantor’s liability extend?

The extent to which a guarantor is liable will either be limited to a certain amount or the entirety of an amount borrowed. However, even in circumstances where a guarantee is limited to a certain amount, a guarantor may be liable for enforcements costs and the interest on the outstanding debt, which is likely to accrue, over and above the principal amount.

If the creditor calls upon the personal guarantee and the guarantor defaults, the creditor would be in a position to institute court proceedings for breach of contract or institute bankruptcy proceedings, thereby putting the guarantor’s personal assets at risk.

Setting aside a personal guarantee

There are several circumstances that can lead to a personal guarantee being set aside, which include:

1. Duress

Where a party’s consent to a contract is induced by duress, the contract is voidable by the aggrieved party. The threat can be actual or threatened violence or unlawful restraint to the person or to property; or it can be economic duress, such as a threat to terminate a contract. In order to prove economic duress, a party must demonstrate that the economic pressure being applied was illegitimate and that the party would not have entered into the contract but for the illegitimate economic pressure.

2. Misrepresentation

A party who has been a victim of misrepresentation (including an innocent misrepresentation) may rescind a contract, if that party was induced to enter into it by the statement made.  This remedy is usually only actionable where the other party to the contract has made the misrepresentation relied on.

3. Undue Influence

Undue influence applies when one party is able to exert influence over another, to the extent of preventing them from exercising independent judgment, and uses this influence to force them entering into a contract. The undue influence can be an actual (express) influence; and it can be an influence, which is presumed from the special relationship between the parties.

4. Breach of Duty to Disclose

Generally, the beneficiary of  personal guarantees is not under a duty to disclose material facts to the guarantor and the guarantor is under an obligation to inquire into and determine all the relevant facts. However, it has been established that a beneficiary under a guarantee may sometimes be under a duty to disclose unusual facts, not known, to a prospective guarantor and that if it fails to do so, the guarantee will be void.

What do our solicitors say about personal guarantee laws and liabilities?

Eager to secure funding, many individuals and especially new business owners, sign personal guarantees without fully understanding its implications and the real risk it may pose to their personal assets. It is imperative that, prior to signing a personal guarantee, you seek legal advice from an independent solicitor in order to ensure that you fully understand the legal ramifications.

If a creditor is threatening to or has instituted legal proceedings against you based on personal guarantee, you should immediately seek legal advice. Proceedings such as those instituting bankruptcy proceedings are subject to strict time periods.

Eldwick law has a team of experienced solicitors, who can assist at any stage, be it the provision of initial advice or assistance in bringing/defending legal proceedings.

Is it a penalty? It depends on its goal….

Understanding penalty clauses in contracts is crucial for anyone involved in legal agreements or business dealings.

In this article, we’ll delve into what a penalty clause is and why it’s significant in contract law, with a particular focus on the landmark 2016 case, Cavendish Square Holding BV v. Talal El Makdessi.

This case reshaped the legal approach to penalty clauses, establishing new guidelines for when they can be enforced.

We’ll discover the key aspects of this ruling and its implications for contracts. To bring this to life, we’ll also examine a real-world example from Eldwick Law, showcasing how these legal principles are applied in practice.

This guide serves as a valuable resource for anyone looking to gain a clearer understanding of penalty clauses and their role in contracts.

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What is a Penalty Clause?

Broadly, a penalty clause is a contractual provision that levies an excessive monetary sum unrelated to the actual harm against a default party. They are generally unenforceable under English Law.

What is the test for deciding whether a provision is a penalty clause?

The landmark case of Cavendish Square Holding BV -v- Talal El Makdessi [2016] AC 1172 replaced the old test of whether a penalty clause was a “genuine pre-estimate of loss“. In Makdessi, Mr El-Makdessi agreed to sell his stake in a marketing company to the Claimant.

The parties entered into a contract, which included certain restrictive covenants (requiring a party to either do or refrain from taking a specific action) that he would not engage in competing activities. If he did, then he would not be owed the final two instalments of the sale price and further, the Claimant could purchase his remaining shares within the business.

Mr El-Makdessi breached the non-compete clause in the contract, but argued that the clauses were unenforceable as penalty clauses. However, the Supreme Court held that both clauses were primary obligations and therefore not subject to the penalty rule.

What does it mean?

Lords Neuberger and Sumption (with whom Lords Clarke and Carnwath agreed) gave the leading judgment restating the penalty rule. A contractual provision is penal if, as a matter of construction:

1. It is a secondary obligation; and

1. It seeks to impose a detriment on the defaulting party, which is out of proportion to any legitimate interest of the innocent party in the performance of the primary obligation.

Primary Obligation vs Secondary Obligation

A primary obligation is essentially an obligation that has been imposed on both parties to carry out whatever they have promised to do, whereas a secondary obligation, would set out what the penalty is in the event of a breach of contract.

As to what may constitute a “legitimate interest”, Lords Neuberger and Sumption said the following:

“The innocent party can have no proper interest in simply punishing the defaulter. His interest is in performance or in some appropriate alternative to performance. In the case of a straightforward damages clause, that interest will rarely extend beyond compensation for the breach, and we therefore expect that Lord Dunedin’s four tests would usually be perfectly adequate to determine its validity. But compensation is not necessarily the only legitimate interest that the innocent party may have in the performance of the defaulter’s primary obligations.”

In his judgment, Lord Hodge also noted that where the primary obligation which has been breached is to pay money on a specific date, the innocent party’s interests are normally fully served by the payment of the specified sum together with interest and the costs of recovery.

Penalty Clause Case Study

We recently acted for a client who had been ordered to pay the entire sum due under a settlement agreement.

His liability under the settlement agreement represented approximately 5% of the total settlement sum, but he was jointly and severally liable. Accordingly, when he failed to make payment, the creditor successfully obtained a judgment ordering our client to pay the entire sum due under the settlement agreement, less any payment he had already made.

In practical terms, this meant that he became liable for a sum almost 10 times that he was originally liable to pay. We appealed, arguing that this was a penalty clause as it imposed a secondary obligation upon our client.
We obtained permission, but shortly before the hearing, we settled on favourable terms.

These examples highlight why it is important you understand each provision when entering into contracts, what could be classed as a primary or secondary obligation, and the remedies available to either the innocent party or defaulting party in the event of a breach, especially if there is unequal bargaining power between the parties.

Our commercial litigation team at Eldwick Law have the expertise in drafting and advising on contracts and can assist you in the event of a dispute.

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