When you sign for a business loan, the bank or lender usually requires you to sign what is called a personal guaranty. This means that you agree to be personally responsible for the debt the company owes. So if the company defaults on the loan, the bank can come after your house, your savings and your paycheck. Because it is so important to understand what you are signing when you run a company, it is necessary to be sure you don’t confuse your limited liability with an absolute shield for your personal finances.
As for the title question, the phrases ‘personal guarantee’ and ‘guaranty’ are used interchangeably. They both refer to a document you’re going to sign that says you personally will pay the debt if the company can’t pay. A guaranty is a contract to answer for the debt of another, and it has to be in writing and signed by the guarantor (or someone legally authorized to sign for them) to be enforceable. So the real difference isn’t between the two words. It’s between the kinds of guaranty a lender can hand you.
Lenders want one for two reasons: more assets to collect from, and the belief that it puts the personal “skin in the game.” In other words, the guaranty helps ensure that the small business owner will strive as hard as possible to repay the debt. As long as the company keeps paying, the guarantor’s risk is minimal. But the lender can go after the guarantor’s personal assets and income if the business stops paying. Watch for wording that makes you “directly and primarily liable.” That means the lender is not obligated to seek repayment from the business first. It doesn’t even have to wait for a default. It means the guarantor can be treated as if they were the original borrower from day one.
A guaranty of one specific loan generally ends when that loan is paid. Lenders often propose a continuing guaranty instead, which covers a bank’s entire relationship with a borrower, both past and future, renewals and extensions included. Guarantors may not realize it, but it can reach debts that existed before they signed, and they can incur liability for loan renewals, new loans, and other amounts even after they have divested ownership. It ends only when you terminate it by written notice, following the agreement’s instructions. Until the guarantor gives that written notice, the guaranty remains in place. Picture an owner who pays off the loan, sells the company and forgets the guaranty exists. The new owners borrow from the same bank and default. Who gets stuck with the debt? The original owner. It doesn’t matter that the company has changed hands, under the terms of the continuing guaranty the bank can still go after the old owner. Even a proper notice has limits: The guarantor’s notice ends only prospective liability, not liability for the past. Existing balances, with interest and fees, stay yours until paid in full.
An unlimited guaranty is precisely what it sounds like: There is no limit on the amount, term, or scope of your liability. For a limited guaranty, you are liable only up to a certain dollar amount, until a specific date, or only for specific loans. Limited guaranties are most common when the guarantor owns a business with one or more other co-owners. In that situation, the owners naturally don’t want to be on the hook for the full amount if all they own is a fraction of the company. Instead, they may want to limit their liability in some way. Each may agree to limit their liability to an amount equal to their ownership stake in the company, or a bit more, though the lender may want the total over 100 percent as a cushion in case one owner can’t pay. A cap can also be a simple “no more than” dollar figure below the full debt. A personal guaranty is a contract, and like any other contract, the terms are negotiable. Too many owners just sign the first draft.
Now say four owners each sign an unlimited guaranty. None of them owes just 25 percent. Most guaranties make liability “joint and several,” and North Carolina law imposes it even when the document is silent. Stated another way, each guarantor is responsible for 100% of the debt regardless of the number of guarantors. A bank can seek payment from any one partner for the whole loan, or from all four, or from any combination. If a co-guarantor goes bankrupt, is released by the lender or disappears, you are on the hook for all the debt as if they didn’t exist. If the business defaults the creditor can sue one of the guarantors for the full amount owed. The guarantor will end up paying the debt but can try to recover contributions from the other guarantors. What you can’t do is force the lender to collect part of it from someone else.
Next, check whether yours is a guaranty of payment or of collection. Under a guaranty of payment, the lender does not have to try to collect the debt from the debtor first. A “guaranty of collection” on the other hand means the lender must try and collect from the debtor first. It has to take certain “legal” steps to obtain payment and only after all those steps have been exhausted can it then turn to the guarantor. Because a guaranty of payment gives the lender so much flexibility, many lenders prefer these types of guaranties, and nearly every form says “payment,” though the owner of a prosperous business might negotiate collection.
Then there is set-off. If you bank where the business borrowed, a set-off clause means the bank can take funds from your personal accounts and apply them to the business’ debts, without notice, except certain IRS or trust accounts. The bank can do it because you have contracted to give them that right.
Death doesn’t end it either. If the personal guaranty does not specifically include a provision to the contrary, the obligations incurred under the guaranty will not terminate upon the guarantor’s death. As a result, the personal liability of the guarantor upon the guaranty will survive his or her death and will be transferred to the guarantor’s estate. Lenders rarely release an estate unless someone acceptable to them steps into the guarantor’s place, and a release-and-replacement provision takes careful drafting by an attorney or other professional.
So, are a personal guarantee and a guaranty different? They’re not. The fine print is what decides how much you owe. Check the language. Make sure it is what you want and understand what it says. Negotiate for limited guaranty, negotiate for release, negotiate for collection. Understand what you are signing. Get independent advice from a licensed attorney, and if your business is already behind, find out exactly what your guaranty commits you to.
