Personal guarantees, SME debt and “vulture” funds – a recent decision gives grounds for borrowers to
As so-called “vulture” funds put the squeeze on SME borrowers to dispose of assets to liquidate their portfolios, we need to be reminded that the funds are set up to operate exclusively for the benefit of their shareholders and not borrowers, and often expect to recover more than the borrower or its guarantors are legally obliged to give.
To all intents and purposes, portfolios bought by foreign funds arising from bank deleveraging comprise loans that share certain characteristics. Assets securing loans to companies are still in negative equity, and they are personally guaranteed. The funds are unconcerned. They buy portfolios on the basis of mark to market value, in other words, the price at which the asset securing it could be bought or sold on the date the loan is bought. Having disposed of low hanging fruit by selling off non trading property assets, funds are now rummaging around to see what more they can squeeze from their SME borrowers
Irish SMEs are typically far smaller than their European or US counterparts. Their size would be classed as micro businesses in other territories. The proof of this is how few opportunities for investment there are for venture capital funds looking for companies turning over €50m (which is a typical SME abroad, but a medium sized company in Ireland).
In Ireland the reality is a very good company generates a good standard of living for one family. Typically it will have done so for one and a half generations, arising from which certain lifestyle and other decisions are made by its promoters. Among these are borrowing decisions; to upgrade properties, or to invest in new product lines. The recent Kenny’s of Galway car company receivership illustrates this.
In this case, Finn Funding Investments DAC (“FFI”) appointed a receiver on foot of a charge created to secure a loan taken out from Ulster Bank to upgrade their showrooms. The loan was sold by Ulster Bank to FFI. FFI now seek to recover money loaned (but for which they will have paid the then value of the property).
Two things impact on their ability to get as much back as possible; the value of the security, and the appetite (and ability) of the principals to dip into profits from future trade to repay a sum in addition to the value of the security. From FFI’s point of view, it is tempting to hold out – after all they have security over the assets of the Company, and also personal guarantees from the Directors for any deficit.
Personal guarantees for company debts are a peculiar feature of the Irish SME landscape. Originally they were part of the price paid by borrowers to avail of the buccaneering lending of Anglo Irish Bank. Their attractiveness quickly became apparent to Anglo’s more prosaic competitors and soon they became typical.
In the above circumstances, often the owner of the debt promises a Faustian pact with the guarantors; work with us on the principal sum, and we will “do what we can” on the remainder. In doing so they separate out two categories of debt, corporate and personal; divide and conquer. While this may have had some meaning when personal insolvency meant 12 years (and the rest) a bankrupt, in these more enlightened times there are better ways of handling this type of debt using the Family Home Protection Act 1976, Land and Conveyancing Law Reform Act 2009 and The Personal Insolvency Act 2012 (as amended).
Many Director/Guarantors believe taking on the owner of their debt is a recipe for disaster, but this is not so. Two things are typically critical to them; their ability to generate an income from the business, and to keep their family home.
In the Kenny’s case this is likely to play out in two ways. In relation to the company debt, the Directors have correctly moved to retain control of their business by seeking court protection with the appointment of Neil Hughes as examiner which trumps the receiver’s appointment. If the company’s application was unsuccessful and the receiver was re-instated, not only would the Directors lose the company, but they would also lose their current livelihood.
The examiner’s appointment gives the company 70 days (which can be extended to 100 days) in which to put a scheme of arrangement to its creditors. If the creditors are not “unfairly prejudiced” (i.e. if they would make more money if the company was put into liquidation), their grounds for opposing the scheme of arrangement are extremely limited. In relation to the Kenny’s example, FFI’s exit will be the value of the security they hold, which typically means the property or any assets secured with a floating charge.
“But what of the personal guarantees?” I hear you clamour! “Aren’t the Directors going to lose all?” you plead! Typically there has been a deficit between the value of security and the amount outstanding on the loan, and this amount is a personal liability of the guarantors. Recovering money on foot of this personal liability though, is proving to be more and more difficult.
Recent changes in the law
In the limited jurisprudence available following the additional protections afforded to the family home in the Personal Insolvency (Amendment) Act 2105 and elsewhere (in the particular circumstances of the case of Muintir Skibbereen Credit Union v Crowley & Anor and Muintir Skibbereen Credit Union v Hamilton & Anor) the Court of Appeal confirmed the High Court decision that an order under S31(2)(c) of the Land and Conveyancing Law Reform Act 2009 (an order for sale of land pursuant to a Judgment Mortgage and consequent distribution of proceeds) should not be made, as to do so would leave an innocent spouse who was not party to the loan or the security documents on foot of which the judgment mortgage was obtained, without a family home.
While the reasoning for the decisions in those cases had to do with the consequences of the personal guarantees being extended to the disposal of the family homes of the guarantors, their significance are the external circumstances the Court considered in assessing whether it was correct to do so.
Directors of companies that have come through the worst of the recession but are still dealing with acute legacy debt are well advised to look past the vulture’s empty promises, and look for a comprehensive resolution of all liabilities in a constructive and meaningful way. The funds might also consider limiting their expectations, because less pleasant surprises might also lie in store for them.
Barry Lyons specialises in the area of commercial litigation, insolvency
and corporate recovery and can be contacted at email@example.com, or 01 539 00600
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