Taking a guarantee or third-party security from an individual: things to consider

An individual must have the legal capacity to enter into a contract. Unlike corporate entities, individuals are generally presumed to have capacity to enter into contracts unless they fall into the following categories:

1. Minors: Contracts entered into by a person under 18 are typically voidable.
2. Lack of mental capacity: If an individual lacks the mental capacity to understand the contract, it may be voidable unless it is deemed fair and reasonable.
3. Intoxication: A contract entered into whilst intoxicated may also be voidable if the individual was incapable of understanding its terms.
   To avoid enforceability issues, lenders should verify the individual's capacity and obtain independent legal confirmation from the individual’s legal advisor.

A bankrupt individual cannot grant valid security over their assets, and if they are declared bankrupt any existing security may be challenged. Lenders should seek to include representations and warranties in the relevant security or guarantee document to confirm that the individual is not bankrupt or subject to any bankruptcy proceedings at the date of the agreement. An express provision should also be included to address any bankruptcy risk, ensuring that the lender can enforce its security if such circumstances arise.

When taking security from an individual, lenders should consider what will happen in the event of the individual’s death. Generally, contractual obligations will pass to the individual’s personal representatives but some agreements may automatically terminate on death.
To mitigate uncertainty, lenders should ensure that this matter is explicitly addressed, for example, by permitting early termination or enforcement if the individual dies and ensuring that there are provisions outlining how notices should be served on the personal representatives of their estate.

In the context of personal insolvency, guarantees and security given by individuals may later be scrutinised as transactions at an undervalue (TUVs) under the Insolvency Act 1986 (IA 1986). A TUV arises where:

1. no consideration is provided by the borrower/creditor in return for the guarantor’s obligation; or
2. the consideration provided is significantly less than the value of consideration provided by the other party.

For example, if a spouse provides a guarantee over jointly owned property to secure the other spouse’s business debts but derives little or no direct benefit from doing so, that guarantee could be open to challenge.

A trustee in bankruptcy may apply to the court to set aside such a transaction if it occurred within five years before the bankruptcy and the individual was insolvent at the time or became insolvent as a result of the transaction.
Separately, a guarantee or security may also be challenged if it was entered into for the purpose of putting assets beyond the reach of a creditor or otherwise prejudicing a creditor’s interests, with no requirement for the individual to have been insolvent at the time.
For lenders, this means that security may be at risk of being unwound in bankruptcy proceedings. It is therefore important to record the commercial rationale for the guarantor’s involvement, including any indirect benefit to the guarantor, and to ensure the guarantor both receives and acknowledges having received independent legal advice. If the transaction is later challenged, having this documentation may strengthen the lender’s position.

Undue influence is a frequent ground for challenging the enforceability of guarantees, particularly in cases where a spouse provides security over a jointly owned matrimonial home to secure business debts. To reduce this risk, lenders should adhere to the Etridge principles, by ensuring that:

• the guarantor receives independent legal advice from a solicitor,
• the solicitor confirms in writing that they explained the risks and obligations to the guarantor, and
• the guarantor signs a declaration acknowledging their understanding of the transaction.

The scope of the Etridge principles has recently been widened by the Supreme Court decision in Waller-Edwards v One Savings Bank (2025). In this case, although the mortgage was taken out jointly, part of the loan was used solely to repay the partner’s personal debts. The Court held that where any non-trivial part of a joint loan benefits only one party, the lender is “put on inquiry” and must take reasonable steps such as ensuring the other party receives independent legal advice to confirm that they are entering the transaction freely and without undue influence. This decision reinforces the need for lenders to assess the purpose of joint loans carefully and to ensure that the parties obtain legal advice confirming that they understand the implications, even where the loan is structured as a joint borrowing. 

Misrepresentation provides a separate basis for challenge. If a guarantor enters into a guarantee or grants security on the basis of false information, the agreement may be set aside. For lenders, this risk may be mitigated by ensuring that (1) all material facts are disclosed, (2) the guarantor has a clear and accurate understanding of the extent of their potential liability, and (3) the legal advice they receive expressly addresses the extent of the obligations and the associated risks under the proposed documentation.

Another ground for challenge is if the transaction is considered to be a preference. This may arise when someone is deemed to give priority to one creditor over another, when they are in financial difficulties. Transactions entered into in the two years preceding the person’s bankruptcy (or up to five years if the transaction was made at an undervalue) may be challenged. If a court determines that a preference occurred, the transaction may be set aside. To minimise this risk, lenders should take steps to confirm that the individual providing the guarantee is not under financial distress and is entering into the agreement voluntarily, for bona fide commercial reasons.