Guarantees and sureties… small print, big consequences
Despite the fact that interest rates have plummeted in recent years, it is still not easy to obtain financing for your business. In the event that your company cannot provide any mortgage or pledge in the form of real estate or substantial claims, it is possible that the bank will ask you, as shareholder/business manager, to provide a surety for the obligations of your company.
A well-known surety is the personal guarantee, whereby you, as shareholder/business manager, stand surety vis-à-vis the bank for the repayment of a loan taken out by your company. If, in the event of non-payment, the bank declares the full amount of the loan (and possibly the balance of other loans running with this bank as well) due and payable, the bank may address you directly.
In order to (apparently) limit such risks, the bank can propose a cash deficiency commitment. This is generally understood to be a commitment by a shareholder to provide financial assistance to his company in the event that the company suffers from liquidity problems and is (temporary) unable to repay the loan. A standard clause can be the following: “X (the shareholder) undertakes that company Y will always dispose of sufficient liquid assets in order to meet its obligations towards Z (the bank) and will, in case of insufficient liquid assets, contribute additional assets to the company”.
In theory, a cash deficiency commitment is more closely related to the so-called comfort letter than to the personal guarantee, because in principle it does not create a direct payment obligation from the shareholder to the bank. In the event of non-payment, the bank will therefore have to rely on common liability law and will have to provide proof of its damages due to the shareholder’s non-performance of his commitment to provide the company with (additional) financial resources. The philosophy of such a clause is to assist your company in the event of a temporary liquidity shortage, rather than to be directly liable vis-à-vis the bank for the entire sum of the outstanding credit, as in the case of the execution of a personal guarantee.
Unlike the personal guarantee, a cash deficiency commitment is not regulated by law. This means that, as a matter of principle, the parties are allowed to define the contents of this contractual obligation themselves. In practice, the bank will often strictly define this obligation, for example by negotiating an obligation of direct payment to the bank upon first request or by extending the contractual obligation to all credits contracted with this bank. There will often be no maximum limit, which means that in case of insolvency you will still have to cover the entire outstanding credit. The nature and scope of such an obligation (autonomous guarantee or requalification as a personal guarantee, etc.) may therefore be the subject of much subsequent debate.
The sometimes unclear definition of such an obligation – whereby the court has to reconstruct the “real” intention of the parties afterwards – and the lack of a legal framework and settled case law in this respect, implies that the parties may create considerable legal uncertainty for themselves.
If, moreover, a judge rules that your cash deficiency commitment was not only a promise to the bank but that it also entitles your company to its own right to the promised financial support in the event of a liquidity shortage, and you unexpectedly lose control of your company – just think of a provisional administrator in the event of a protracted shareholder dispute – then you risk suffering losses on many fronts: your contribution as a shareholder, the sums claimed by the company and the (damages) claims by the bank.
In order to avoid such legal uncertainty, it is advisable not only to limit the time and scope of your contractual obligation, but also to carefully analyze the wording used. What may at first appear to be a formality can quickly escalate when your company is confronted with liquidity problems, defaulting debtors, etc. Often a personal guarantee with clear limits will be a better starting point than an unclearly formulated cash deficiency commitment.
Bruno Thoen en Nathan Declerck
De Langhe Advocaten
Published in VOKA – Ondernemers West-Vlaanderen/Oost-Vlaanderen, edition februari 2019.
