You’ve been sued on a personal guarantee, and it looks like you’re facing a judgment. You’re worried about the financial consequences. You want to know if you can settle after a lawsuit has been filed. The honest answer is that it depends, and no one can promise you an outcome. Guaranties are important in workouts, restructuring and litigation, but their strength depends on how they are drafted, administered and enforced. Enforcement litigation is often where the pitfalls lie. So before anyone makes or answers an offer, it helps to understand what you signed.
A guaranty is a separate and independent legal obligation. A personal guarantee is a promise to pay if the party who has primary obligation to pay does not do so. Lenders, landlords and funders ask for one when the business lacks the credit or collateral to stand on its own; it gives them an extra layer of protection in case the entity fails to perform. A key component of the personal guarantee is that when the business does not meet the repayment obligations, the lender can go after the person who signed it. That person is often someone with a stake in the business, such as an owner. But not every guarantee is the same, and the differences matter once a creditor files suit.
The first thing to look at is whether you signed a guaranty of payment or a guaranty of collection. In practice, a guaranty of payment is a much bigger “stick” than a guaranty of collection. Under a guaranty of collection, the creditor is required to first try to collect from the business before it can take action against the guarantor. In contrast, in a guaranty of payment the creditor could sue the guarantor directly, without first suing the business.
Next, check how much of the debt you actually guaranteed. A full (or absolute) guaranty means you are 100% on the hook for every penny. A limited guaranty means you are responsible only up to a certain amount or percentage, or the amount you are responsible for burns off or sunsets over time. A nonrecourse (or bad boy) guaranty means you are on the hook only if certain things happen, like fraud, the borrower files bankruptcy or the money is mishandled. If a partner signed too, the guarantee should say whether you are liable for the total debt (both of you) or just a share of it. That’s why it’s important to find out how much you’ve guaranteed - and exactly what kind of guaranty you have. This will help you decide whether to settle the guarantee or fight it in court.
Courts do look closely at guaranties because of the huge risks involved. You are bound only by the precise words of the contract, and a court won’t ‘expand’ it in any way. That means courts can’t assume that a guarantor’s commitment was something other than what the guarantor said. For creditors, that cuts the other way too. Unfortunately, speed and convenience can win out over detailed consideration, which can lead to later problems when it comes time to enforce. Choice of law, venue and jury trial waiver clauses are also frequently ignored, but can prove to be critical if the agreement goes south.
Contract Defenses
Guarantors don’t usually go down without a fight and anyone who takes them to court for a guarantee they signed assumes that will be the case. Contract defenses can include inadequate consideration, lack of authority or capacity, the statute of frauds, the statute of limitations, ambiguity, unconscionability, and fraud in the inducement. Guarantors may also object to a lack of advance notice of events that increase their risk, such as a material change to the loan or the borrower’s default. Some courts have even recognized negligent loan administration as a tort when it increases the guarantor’s risk beyond what the guarantor bargained to assume. Guarantors also often raise the contract defenses the borrower itself could raise. With a guaranty of collection, it is also common to argue that the creditor failed to pursue the business or the collateral first.
A guarantor can waive many statutory and legal defenses in a guaranty. It’s possible that equitable defenses, such as unclean hands, estoppel and laches, might be used to defeat broad waiver language. Equitable defenses are based on fairness; they seek to prevent an injustice or wrong. Which defenses survive a waiver clause has been the subject of frequent litigation.
If the borrower goes bankrupt, there are other potential defenses. The guaranty and the payments under it might be attacked as fraudulent transfers, especially in a multi-entity transaction if the guaranty made the guarantor insolvent. A bankruptcy court also has the power to put enforcement of a guarantee on hold to protect the borrower’s reorganization, or because the relationship between the borrower and guarantor is too intertwined. If the lender has already sued the guarantor, the court may stay that action.
None of these defenses guarantees a win in court, and we would never suggest otherwise. Each of these can potentially thwart or delay enforcement. A creditor weighing that risk has more to think about when making a settlement decision.
Not a Law Firm
Delancey Street is a business debt settlement company, not a law firm. When you have been sued, you need a lawyer. When litigation or bankruptcy is the right call, we refer owners to a vetted independent attorney. Our senior advisors negotiate with funders and lenders for less than the full balance owed; we do not sell you another loan. A first consultation is free and confidential, and if a case cannot be won, or a cheaper option exists, we say so on the first call.
The Next Time You Borrow
One last lesson, for the next time you borrow. Whatever the leverage a borrower has when negotiating a loan or lease, it will have less once the commitment letter is signed. Before you sign any lease or contract, read it and try to understand it fully. And while every bank and landlord has different policies when it comes to personal guaranties, one alternative would be to look for other financing options. Another option is to offer up other assets to back the loan or lease to eliminate the need for a personal guaranty, such as a letter of credit, a cash deposit or unencumbered property.
