Can a business lender pursue your personal assets? Short answer: yes, in two main ways. One, if you signed a personal guarantee. And two, if you ran your business in such a way that a creditor can “pierce the veil” of your LLC or corporation to reach you personally. A signature on a personal guarantee really does open the door to exposure of personal assets.
A Personal Guarantee
A personal guarantee is basically a legally binding promise by an individual (typically the business owner) to fulfill the financial obligations of another party (typically the business). Guaranty and guarantee mean the same thing. It means just what it sounds like: If the business can’t pay back the loan, you will. In many business deals, the personal guarantee is customary. Don’t take it personally when someone asks you to sign one. It’s not a reflection of you or your business. That said, try to avoid signing a personal guarantee if you can.
Lenders use them more than anyone. Many lenders have them in their contract as an extra guarantee that a loan will be paid back. If you’ve ever received an SBA loan, you’ve signed one. The owner and the business are both on the hook for the debt. Many suppliers and vendors insist on a personal guarantee before they will sell you goods on credit. For example, if your construction company doesn’t pay for supplies, your supplier holds you personally responsible. This is also very common in commercial lease agreements and equipment leasing, such as for an office copier or a point-of-sale system.
If you have a business with multiple owners, expect that all of them may be asked to sign for a loan, even if they only own a small piece of the company. That means your silent partner, who is not involved in running the business, could end up with more skin in the game than he or she ever intended to have.
If the Business Defaults on a Loan Payment
Put simply, if the business defaults on a loan payment, and cannot repay the debt, then the lender can come after the assets of the guarantor. A guarantor is liable for the debt to the same extent as the business. If you are personally guaranteeing a loan, and the business can’t pay, the creditor can go after you or the business in any order. In theory, the lender can sue the guarantor before suing the business, although almost always both are sued simultaneously.
A lawsuit against your business can have knock-on effects. If you find yourself named as a defendant in a lawsuit, the agreement you signed for the loan or other contract may require you to report that fact. If you don’t report it, the loan agreement may be in default.
A guarantee makes the personal liability explicit. It gives the creditor some negotiating leverage. The creditor knows the owner really wants to avoid personal liability, and he or she can use the threat of suing the owner personally to secure better terms in negotiations or the settlement of disputed claims.
In one case, a lawyer was representing a contractor who was very unhappy with the work of his supplier. The supplier had sent the wrong materials, delayed shipments, and missed commitments. All that caused the contractor to have to delay the project. He was forced to give the owner financial concessions. He only paid part of the contract amount to the supplier because he felt he wanted to work out a deal and get back some of the money he lost by paying concessions to the owner.
The trouble was that he had also, years earlier, signed a credit agreement with that supplier. It included a personal guarantee, which he never noticed or remembered, but the supplier managed to use as leverage. His negotiating position was greatly compromised. He only settled for a much worse result because he had to face the thought of being personally sued along with his company.
Guarantees can also reach your credit report, though it all depends on what situation you’re in. If you guarantee a traditional business loan, that will show on your business credit report. Paying on time builds credit, and if you miss payments that will hurt your business credit score, but your personal credit probably won’t be touched at that point. If you default on the loan and the lender pursues the guarantor, personal credit can start to get a hit. Catching it up right away may mean that you won’t see any impact. If you don’t pay it and it goes to collections, then it will likely show up on both your personal and business credit.
Some business lines of credit and business credit cards are reported on your personal credit. That means on-time payments can boost your personal score, but the balances also factor into your credit utilization ratio and debt-to-income ratio, making it harder or more expensive to qualify for personal loans.
How Do You Compromise the Limited Liability
You don’t have to sign a personal guarantee to become personally liable, either. The main advantage of an LLC or a corporation is that it keeps your personal assets safe. For example, in Pennsylvania the general rule is that members of an LLC are not personally responsible for company debts, but how you conduct the business can create a risk that a creditor will pierce that protection. If that happens, the creditor gets past the corporate “veil” that normally prevents creditors from grabbing the personal assets of the owners.
How do you compromise the limited liability you’re counting on?
- By forgetting to sign business contracts in the company’s name.
- By signing documents without including your formal title like president or managing member.
- By paying your personal bills with company funds.
- By having personal money in business accounts or vice versa.
- Lastly, continually paying yourself but not your creditors can get you in trouble.
If you are behind on business debts and have signed any personal guarantees, go find out what you actually signed, and read it. A guarantee can be a license for creditors to collect from your personal assets, and it can give creditors leverage over you. Most small business owners want to keep their personal assets separate from the risks of their business. It pays to know what you’re dealing with before you go to the table to negotiate with a lender or supplier.
