Personal Guarantees Like “T-shirt Body Armour”

I put it to the wise community at P2P Independent Forum whether personal guarantees count as secured lending.

Before I share their views, here are two unavoidable definitions:

Personal guarantee

Business borrowers sometimes give their “personal guarantees” that they will repay a business loan using the owners’ and directors’ own money and property, if the business is unable to do so. They will often support this by submitting evidence of their wealth.

Secured lending

Sometimes a borrower can’t or won’t repay all of a debt. When this happens, it can be possible for a P2P lending company to repossess their property and sell it, so that it can reimburse us lenders from the proceeds.

Getting a court order to repossess and sell a property is much easier to do if the loan is “secured” against the borrower's property and possessions before the contract begins. (Contrary to popular belief, it’s not impossible with an unsecured loan. Just more difficult.)

It's even easier if it is secured against specific property that is specified in the contract, rather than just generally secured against all property.

It can get more complicated than that, but that's enough of an explanation for this article. (If you want to know more, see our glossary of Peer-to-Peer Lending Definitions.)

Is a “PG” secured lending?

Definitions over.

The P2P lending websites themselves differ on whether a personal guarantee is secured lending; for example, rebuildingsociety says yes while Funding Circle says no. Both of them do loans based on secured lending and personal guarantees. Sometimes both for the same loan.

“pikestaff”, writing on the discussion board, wrote: “Not all PGs are equal.”

Referring to the fact a personal guarantee can be made by someone with no money or property, he added: “If the PG is supported by assets then the PG is a weak form of security but will the assets be there when needed/will the guarantee be enforceable?”

webwiz also referred to the variability of a personal guarantee: “A PG depends on the person. Some will offer a high degree of security but others will be worthless.”

He signed off with “caveat emptor” (let the buyer beware), but in practice it is not easy to see what a borrower's character is like through a P2P lending website.

“harveyspecter” had this view: “Only reason [Funding Circle] take them is it directly ties the director/shareholder to the business and generally prevents them from moving all their trade to NewCo Mk. 2 Limited and writing off the loan in the old company.”

What does the data say

Opinions are useful, but, when it comes to lending, not as useful as high-quality data.

Unfortunately, Funding Circle has not done enough lending secured on borrower property yet, nor had anything like enough debts go bad, for us to get a picture from statistics.

If Funding Circle, with it's near 8,000 borrowers over 4.5 years, can't provide anything like enough data, then no P2P lending website can. Even combining all their data together probably won't be enough. And that's if they all gave us access to it, which they don't.

Which shows that the jury must still be out on the effectiveness of personal guarantees.

We put it to a vote

In my poll, 43 people said a loan backed by personal guarantee was not a form of secured lending. No one voted that it was a form of secured lending.

As “GSV3MIaC” said: “It's a form of security like a T-shirt is a form of body armour.”

That's a sensible position for us lenders to take when evaluating a loan until we have some solid evidence to the contrary.