How can I protect myself as a personal guarantor if my business closes?

It is a difficult time for businesses in many industries. Most business loans are secured by a personal guaranty of the business owner. A guaranty is a contract signed in conjunction with a loan or a lease that requires an individual to make a personal payment to a lender in the event that a business fails to make payments. A guaranty can be unlimited, or it can be limited in time, dollar amount or both. Sometimes, a guarantor pledges personal assets to secure the debt, while others do not.

As business defaults are likely to increase, it is prudent that business owners and guarantors understand what a guaranty is and the consequences of signing one, both inside and outside of bankruptcy.

When your business has to file bankruptcy, the immediate benefit is that, once the bankruptcy is filed, the automatic stay stops all lawsuits, foreclosure and collection against the business (the “debtor”). However, the stay only applies to the company that filed, not those who guaranteed the debts. But if you are a guarantor of your business, and you do not file bankruptcy, what happens to you and what are your options? The short answer is that you still have real options.

One option is to make a deal with the creditor. In exchange for the creditor/lender agreeing not to pursue you, as guarantor, you agree to cooperate in the sale of assets of the business. As part of the deal, the creditor would have a say in determining when and how assets are liquidated. Given the current environment, where creditors are under pressure and may act quickly to pursue guaranties in the face of even minor defaults, obtaining protection against such pressure may be especially important for a guarantor.

A second option, which may even allow for a longer protection, is for the business debtor to seek the aid of the bankruptcy court to obtain an injunction against the lender. The debtor may be able to obtain an injunction prohibiting the lender from bringing an action against the guarantors - for the length of the bankruptcy case. This can even put a stop (albeit possibly only temporary) on any actions the lender has already started to collect.

Extending the protection of the stay to the guarantor is particularly important if the guarantor is also the person running the business, as it allows the person to concentrate their efforts and attention on the business - and not to defend lawsuits.

Legal Strategy

If a business is shutting down outside of bankruptcy, the business and the guarantors should be prepared early on to develop a legal strategy to minimize their liability and exposure. A bankruptcy attorney is in a position to review and assess the nature of the assets and come up with options for negotiations with creditors. Taking a proactive approach to your business’ issues makes it possible to maximize negotiation options and avoid and minimize unnecessary risks and liability.

Avoid Giving a Personal Guarantee

If you have not signed the guaranty, your best protection is to avoid signing in the first place. One possible way to avoid giving a personal guarantee for a business is to offer a blanket lien on all assets of the business for the amount of the loan. You should push for this at the start.

If a personal guaranty has been signed, it is important to understand what was pledged by reviewing the nature of the guarantee. Is it unlimited? Is it cross-collateralized and/or cross-defaulted (meaning one default can cause liability on all obligations to that creditor)? Are there primary guarantees that allow the lender to come after you before they go after your business?

Guaranties can get complicated and extend beyond what may have been expected when they were signed. Consult with an experienced attorney before you are in the midst of a crisis to better safeguard your rights.