Invoice Finance – Personal Guarantee or Indemnity (Fraud Warranty)

Invoice Finance providers typically require some form of personal security from the directors of a business. This can take the form of a personal guarantee or an indemnity that some people refer to as a fraud warranty.

It is important to remember that for either to be called upon there would have to be a shortfall in terms of the lender recovering their position.

A personal guarantee means that the directors are personally liable if there is a shortfall on the facility. The personal guarantee is limited to an agreed amount but the directors are liable for any shortfall no matter what the reason.

With an indemnity, the directors only become liable if there is a shortfall and certain things have happened. For example if the shortfall is due to fraud. These requirements will be set out within the indemnity and can be as loose as ‘keeping accurate financial records’. One of the key characteristics of the indemnity is that the personal liability is unlimited.

So in summary:

Personal Guarantee: limited liability but liable no matter why the shortfall occurs.

Indemnity: unlimited liability but only liable under certain circumstances.

An interesting case study is ABN AMRO Commercial Finance plc v McGinn & Ors., Queen’s Bench Division (Commercial Court).23 May 2014.

The business of the company was as importer and distributor of food products. It had a customer base which included a number of the large supermarket chains including Morrisons, ASDA and Tesco. The company purchased large, regular quantities of goods, not necessarily tied to particular orders from its customers. It was often obliged to pay its suppliers before it could receive payment from its customers. Given the scale of purchases it made and the transportation and storage costs it incurred, it needed a financing facility to assist with its cash-flow requirements and it was in those circumstances that the agreement was entered.

ABN Amro (then Venture Finance) originally required limited personal guarantees from the then directors, but in about May 2007 the company served notice to terminate the agreement so that ABN Amro was under pressure to provide better commercial terms. Apparently, indemnities with unlimited liability such as the deeds of indemnity in this case are viewed generally by directors of companies as more attractive than limited guarantees because they are only called upon when the company is in breach, not simply being called upon because a debtor is unable to pay. Accordingly, the directors signed their deeds of indemnity (which replaced their limited personal guarantees) on 2 May 2007.

Prior to 2008, the company operated six different distribution outlets and used three different hauliers within the United Kingdom. In the summer of 2008, the company entered into a distribution agreement with Wincanton Group Limited for them to provide warehouse and distribution services, using a single distribution centre in Milton Keynes and up-to-date technology. It is the companies case that it was the poor performance by Wincanton of that agreement which led to the financial difficulties which the company suffered. There were over and under deliveries and Wincanton failed to produce a complete set of delivery notes. The company became subject to an increasing number of customer disputes. ABN Amro was aware of these difficulties and was supportive initially in the efforts to resolve them. It is the companies case that on about 24 February 2009, the claimant actively encouraged the company to notify new debts, notwithstanding that it was aware that such invoices could not be guaranteed full payment. It is that encouragement which is said to give rise to an estoppel or waiver in respect of debts arising after that date. The claimants dispute this, but recognise that that issue cannot be resolved on this summary judgment application.

Ultimately, following an unsuccessful attempt to enter into a company voluntary arrangement in April 2009, the company was placed in administration on 18 May 2009 and subsequently went into liquidation. The evidence of Mr Michael Stock, a portfolio manager at the claimant is that at the date of the administration, the company’s sales ledger balance stood at £24,439,997. On 16 June 2009, ABN Amro wrote to the company making demand under clause 19 of the agreement for the immediate payment of all funds in use together with discount and costs accrued, amounting at that stage to over £13 million. No payment was received at that stage.

ABN Amro engaged Largo Collections Limited (‘Largo’) a specialist collections agency to collect in the outstanding debts. They were incentivised to do so since they operated on a commission only basis. They had access to the company’s records and computer files. They conducted a collections exercise over a period of two years, assisted by the company’s administrators, PWC and by the directors. Nonetheless as PWC said in their letter of 22 September 2011:
‘We anticipated Largo would face some difficulty in performing the debt collection. We provided them with six boxes of credit notes which the financial director had held pending final sign-off – all of which needed adding to the ledgers.’

The evidence is that by May 2011 it became apparent that further collaboration with the defendants would be fruitless as the company lacked the necessary documentary evidence to challenge the debtors’ grounds for refusing to pay the debt. At the end of the collections process, £5,529,742.27 had been collected from the company’s debtors, leaving a debit balance of uncollected and disputed invoices, after allowances for bad debt and contra trading, of £18,547,977.38. By their letter of 22 September 2011, the administrators acknowledged that the company is indebted to ABN Amro in the sum of £8,924,783.34. That sum represents the debit balance on the company’s current account.

Without going into further detail you can see that the directors had moved away from their limited personal guarantees in favour of unlimited indemnities. However, proofs of delivery fell within the definition of ‘financial records’ in the agreement because they were ‘other information pertaining to a debt’. When ABN Amro asked for the proofs of delivery and the company could not produce them promptly or at all, there was the a breach of that clause even though this was caused by a the deficiencies of a third party haulier.

Having moved away from limited personal guarantees to an indemnity the directors were now being persued in the courts for nearly £9m.