We are seeing an increase in the number of transactions where, as a condition to providing credit facility, lenders are increasingly requesting for a guarantee to be provided by a subsidiary of the borrower.  Also called an upstream guarantee, we look in more detail at these guarantees and directors and boards should consider should a company look to enter into one.

The scenario

You are a director of Finsbury Limited, a wholly owned subsidiary of Broadgate Plc. You are informed that Broadgate Plc is preparing to enter into a new credit facility with Taylors Banking, and as part of this transaction, Finsbury Limited is being asked to guarantee the obligations of Broadgate Plc. This is also known as the “upstream” guarantee.

The first thing that you should consider is whether or not Finsbury Limited should obtain independent legal advice in connection with the proposed transaction.

As a director of Finsbury Limited, the onus is on you to consider whether Finsbury Limited should seek independent legal advice to thoroughly understand the terms and implications of the guarantee that it is being asked to enter into, which may also include negotiating its terms and ensuring compliance with the legal obligations, all of which are critical steps in safeguarding its interests.

It is also likely that Finsbury Limited will be asked to provide certain obligations to Taylors Banking under the credit facility which may include, for example, giving covenants, representations, or warranties in favour of the lender. Where it is proposed that Finsbury Limited is to give such obligations, independent legal advice should be obtained, and it therefore important that the underlying documents are read through thoroughly to understand the obligations.

Additionally, the need to obtain independent legal advice becomes more profound in a scenario where Finsbury Limited is entering into the guarantee without receipt of any consideration from Broadgate Plc, and is thus assuming a contingent liability of Broadgate Plc under the credit facility. In such circumstances, there is a risk that an “upstream” guarantee may constitute a “distribution” under the Companies Act 2006 and, in the event that Finsbury Limited does not have sufficient distributable reserves, it will be unlawful.

Director duties

Within your role, you and other directors should ensure that you are complying with the directors’ duties you owe to Finsbury Limited under the Companies Act 2006.

Companies Act sets out several duties that directors owe to their companies, with one such duty being the requirement for the directors to exercise their powers in the best interests of the company itself, rather than in the interests of the group as a whole. The entry into a credit facility by Broadgate Plc may well be in its interest, but you will need to consider whether it is in the interest of Finsbury Limited to guarantee those obligations, if it is not, then any authorisation may well lead you to breaching your duties to Finsbury Limited.

Further considerations of the board

Are there any other considerations that you should keep in mind?

The main consideration for the Finsbury Limited board is whether the guarantee is likely to be called by the lender, and this depends on the ability of Broadgate Plc to repay or refinance the credit. As a director of Finsbury Limited you will need to consider the actual and prospective financial conditions of Broadgate Plc and the likelihood that it will be able to repay or refinance the credit if, and when, required.

You should also consider the solvency of Finsbury Limited before giving a guarantee. If Finsbury Limited goes into administration or liquidation, the guarantee may constitute a transaction at an undervalue under section 238 of the Insolvency Act 1986, and it may be set aside if you did not properly take account of the interests of Finsbury Limited.

For these reasons, it is important that a board discussion takes place which is properly minuted. If it is determined that there is an overall benefit to Finsbury Limited in facilitating Broadgate Plc’s access to financing by giving the guarantee, it is likely the board will legitimately be able to enter into the documents. By way of illustration, Finsbury Limited may be dependent on being part of a financially stable group of companies where it has access to Broadgate Plc’s management and expertise. Therefore, it is prudent that the commercial rationale for such a decision is properly set out.

Do you need to check your Articles of Association?

Before entering into any guarantee, it is necessary for you, as the director of Finsbury Limited, to check that there are no provisions in the company’s articles which prevent or restrict its ability to enter into a guarantee. Any such restrictions will need to be dealt with prior to entering into the guarantee.

In addition, a corporate check should be carried out to ensure that there are no late Companies House filings, existing security that needs to be released, or any other discrepancies that need to be rectified prior to entering into the guarantee.


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