Sunday, 23 January, 2022
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Why Personal Guarantee for All Bank Loans?

Nironjan Roy

Why Personal Guarantee for All Bank Loans?
Nironjan Roy

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I have been availing overdraft facility from a commercial bank in Bangladesh against a lien of cash collateral and loan amount is only 60 per cent of total cash collateral value. Every year as a part of the documentation, I have to sign a bunch of documents which include personal guarantees. I asked the credit officer about the reason for taking my personal guarantee when I have duly discharged my entire cash collateral based on which bank is fully authorised to redeem my cash security and adjust loans. In response, that credit officer could not reply satisfactorily, instead simply said that this is their requirement. When I further asked him whether such practice is necessary or unnecessary, he kept quiet because the answer to this question is not known to him, not even known to many senior bankers. However, the signing of personal guarantee may be either necessary or unnecessary, but its consequence is very severe. Many people have already started facing dire consequences of executing personal guarantee against sanctioning loans to third parties. This practice was probably inherited from the Pakistani banking system, but unfortunately continues in the modern banking era when personal guarantee is not required at all except one particular situation when a bank loan is sanctioned in favour of a limited company.

What is personal guarantee: Personal Guarantee (PG) is a legal document where the executor who signs this guarantee, provides personal undertaking of meeting or refraining from meeting any specific obligation. With reference to the bank loans, personal guarantor extends additional undertaking of paying off the entire amount of loans if the borrower does not pay off. If the lender, especially banks and financial institutions, is not comfortable with the borrower’s standing about repayment, they demand personal guarantee from a third-party who has good standing and capability of paying off the loan if the borrower fails. Although, personal guarantee is obtained as additional assurance of repayment from third-party and as such, this guarantee should be exercised when borrower completely fails. But the clause and text of the personal guarantee does not specifically mention that, instead it contains a general clause based on which the bank can resort to exercise personal guarantee whenever they will feel to do so. Although personal guarantee is a common form of loan document, under which act this guarantee is enforced is not clear to us. Whether personal guarantee is enforced under Contract Act or Company Act or CRPC / CPC or any other act, is not clear.

When personal guarantee is legally required: In our banking practice personal guarantee is obtained indiscriminately from the borrower and third-party guarantor where applicable against any sort of loans. In reality and from a legal perspective, personal guarantee is not required for sanctioning every loan. For personal loan, the borrower is an individual who is in principle personally liable to pay off the loans. Even, individual borrower is legally liable to dispose of his asset to repay the bank loans. So, personal guarantee is not required for any personal lending.

Similarly, for a proprietorship firm, the owner and the firm are integrated meaning the proprietor himself is legally liable to pay off the loans obtained in the name of his proprietorship firm. Like an individual borrower, the proprietor's personal property can be brought under the lender's obligation to pay off the loan. Therefore, personal guarantee signed by the proprietor will not carry any additional security feature and as such is redundant. For partnership companies, the partners are individually and collectively liable to repay the loan. Even a solvent partner always takes higher risk than other less solvent partners because if other partners fail, only the solvent partner is legally liable to pay off the entire loan and his personal property will come under legal consideration.

So, personal guarantee does not add any additional security for partnership firms. Personal guarantee is exclusively required for sanctioning any loan to limited companies because as per Company Act, directors are not personally liable for their role in running the company. So, directors of limited companies cannot be held liable for the documents they execute as director and as such making directors personally liable to repay the loan does not arise at all. Limited company enjoys its own status and as such can be held liable and even sued to recover bank loans.

However, there are situations where bankers know the directors better than the company itself and without the director, the company will not have any good standing, so in that situation, personal guarantee from the directors is inevitably required. In fact, when the limited company enjoys the highest reputation with strong financial standing, directors are not that important, so personal guarantee has no implication for that company. However, when the director’s standing is adequately stronger than the company itself, personal guarantee carries value. Apart from this, there are some situations where a bank cannot fully rely on the borrower, so the bank may require personal guarantee from the person acceptable to the bank. Excepting these few situations, personal guarantee does not carry any additional security features and as such should be considered as redundant and therefore, should be discontinued.

Consequence of personal guarantee: Personal guarantee is not a simple form of document; rather this is a very powerful and effective legal document. By executing this guarantee, the guarantor assumes sole responsibility and personally guarantees the borrower to pay off the loan. On the basis of personal guarantee, banks will be able to not only make the guarantor personally liable to pay off the loan but also take the right on the guarantor's personal property. Even if borrower defaults, personal guarantor is also considered as defaulter and accordingly reported to

Credit Information Bureau: Obtaining personal guarantee always poses more risk than the actual loan liability. When a third party personal guarantee is obtained, the bank or lender is always found less persuasive with the borrower to recover the loan because there is a personal guarantor as the last defence. At the time of sanctioning loan, personal guarantor may agree to the loan amount but at the time of enforcing guarantee, the guarantor may be held liable for the entire amount whatever remains outstanding at a given point of time which is usually higher than the original loan amount agreed by the guarantor. Even a personal guarantor may be held liable for any loan fraudulently disbursed because he will be made liable for the entire loan balance that remains outstanding in the borrower’s account as fraud investigation takes much longer time.

Lack of fair disclosure: Personal guarantee is a very effective and powerful legal document executed against sanctioning loan and because of executing personal guarantee, the guarantor personally and legally binds himself at highest degree. However, there is no practice of making fair disclosure about the dire consequence of signing this document. The guarantor hardly understands the purpose of signing this guarantee and consequence thereof. In most cases, the bank requests the guarantee to sign just as a piece of paper giving the impression that nothing will happen, but an actual problem arises when the bank intends to enforce this personal guarantee. Last year, one poor couple contacted me stating their plight of signing personal guarantees. Bank sanctioned a loan facility for cloth trading owned by their son and as a part of loan documentation the bank took personal guarantee from that couple. Two years back when their son defaulted, the bank exercised their personal guarantee and consequently, that poor couple had to sell their only paternal house to pay off the bank loan. They are not alone, there are innumerable people including the government officers and journalists who are facing difficulty because of signing personal guarantees without knowing the consequences for their relatives. I personally asked many highly educated people about whether they are aware of the consequences of signing personal guarantees and could not find anyone who has a good understanding about this document. More ironical is that the bank collects personal guarantee signed blank meaning date and amount is kept blank which indicates that the bank can write whatever they want at the time of their need which is completely illegal.

Indiscriminately taking personal guarantee for all types of loan should not be a legal practice and as such must be discontinued. I am confident if the matter is referred to the High Court or if any guarantor being victim goes to the court, fair justice / direction will come out in this regard. Personal guarantee must be taken where legally required, particularly in sanctioning credit facility to the limited company. The practice of sanctioning loan merely relying on personal guarantee and sidelining the actual borrower should not be allowed at all because loan must be sanctioned entirely on the borrower’s standing, not another person. Similarly, obtaining personal guarantees against loans backed by cash collateral must be stopped immediately. Bangladesh Bank should review this practice and advise all commercial banks to stop obtaining personal guarantee wherever not legally required.

 

The writer is a banker, Toronto, Canada