Business Money – Finance and Banking for Business

Guarantees? No such thing

Time for caution

August 2005

In my early days as a banker one of the most inﬂuential mentors I ever met told me: “The guarantee is the easiest security to take and the hardest to realise”.

Robert Lefroy

The word guarantee is intended to convey an impression of a fail-safe foundation but has often proved to be a sad deception. Take a look at the recent history of the term.

Equitable Life guaranteed a certain yield on a particular product. The move was a rash one and falling market yields made it unsustainable. Policyholders went to the courts when Equitable Life tried to change the terms but their victory was a hollow one. The company could not afford to stand behind its guarantee.

The term guarantee has also come into a misuse that has passed in legend – crooks were peddling so-called low coupon deals at times of high interest rates, underwritten by prime bank guarantees. Anyone with an IQ greater than a birdbath was prompted to ask the question as to why a bank would underwrite a risk whilst somebody else, usually a company with a grand sounding title, but trading out of a redundant privy in the further reaches of Accrington, made a risk-free proﬁt on the deal. There are some not very clever people around because far too many parted with large cheques and fuelled the advance fee fraud industry. The term ‘guarantee’ lulled them, dulled their senses, that and the siren call of something for nothing as the deals were always at sub-market rates.

The factoring industry of today has to address a number of challenges, many of which were discussed at our small business factors conference in Birmingham.

The regulation industry is looking around for ways in which to grow its empires and it is only a matter of time before more areas of commercial lending fall within its purview. As it does this, a broader mood change will develop. The concept that those in business should know how to look after themselves will be nanniﬁed by those who believe that everyone should be cushioned from the results of their own stupidity, no matter how dumb they have been.

As an understandable reaction to pension and endowment mis-selling scandals, the ﬁnancial institutions have become perceived as exploitative and not worthy of trust.

Much business written by small factors of late, sometimes ﬁnancing phoenix situations, sometimes ﬁnancing, or re-ﬁnancing cash strapped companies, has been undertaken upon a due diligence visit, best described as cursory, and relying essentially upon a guarantee from the business proprietor. Many of these deals are now moving to collect-out stage following the failure of the business and some court cases will be seen.

Some other court cases will also arise now that the Brumark debate has been resolved and they will be looking back at long gone situations. The guarantors will have moved on and re-built their business lives. I have no doubt that some will claim that they completed the guarantee under the belief, one possibly encouraged by a bank with the prospect of a new, cash earning, loan or overdraft in the book, that the guarantee was a ‘virtual formality’, a reassurance of good behaviour, and that the margin of security in the company was more than enough to secure the liability.

It is no guarantee that in the lottery of our court system the banks will now win and be paid. People with a shattered business behind them, often a shattered marriage too as a direct result, are not usually awash with liquidity. The sight of a hard working, mortgaged to-the-hilt businessman, having tried to make a come-back and creating six new jobs in an area with high unemployment, and with a new wife, a couple of step-children, plus a recently arrived one of his own, being chased under this guarantee may well move a judge to feel that the bank, having just posted a pre-tax of mega billions, is pulling his gouty old leg.

It does not take the most elastic stretch of imagination to picture a lawyer proclaiming: “My client signed the guarantee document in the reasonable belief that the bank had put in place an adequate form of security over the assets of the company. It is now clear that the security was far from adequate and the bank has the audacity to now look to my client to remedy the shortcomings in its procedures. The heartless ogres know that my client can only meet this outrageous claim by selling the roof over his new family”.

Any transaction involving the family home is now wrapped in regulation and the judge may well be persuaded to apply the philosophy to houses which, even if not charged in support of the guarantee liability, constitute the most obvious line of recourse to satisfying a claim.

Moods in courts can be catching and a judge enquiring of a factor the extent of its due diligence, or prudence, in throwing £50,000 at Phoenix Gas Mantles (May 2005) Limited, with its director still in shock from the collapse of a business he resurrected from the ashes of Gas Mantles (March 2005) Limited, might be persuaded that the factor contributed to its own problems. He might disallow claims under a guarantee that was, arguably, signed under pressures of commercial duress and point out that there was no in-depth examination of the company’s prospects for success.

There is a potentially awkward precedent too in the emerging message from the bank factors that some of them are not taking personal guarantees on many of the factoring deals they are writing, streaky though some of them may be if judged by the standards of two years ago.

I am not in favour of anything that restricts the ability of lenders to offer ﬁnance to a business but I remain ﬁrm in the belief that the guarantee is only a long stop, a secondary line of cover. I am becoming anxious that its effectiveness may be diminished by its use in situations which, while maybe not quite irresponsible, are certainly cavalier.

I am only speculating as to the way the courts may go. But if they do, I can guarantee that much pain will be felt in many business ﬁnance houses.

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Guarantees? No such thing