What am I liable for on a personal guaranty, and how do I limit it?

Financing is one of the most vexing problems business owners face. Nearly all banks require a personal guaranty on any financing - and if the loan goes into default, the bank will almost always come after the guarantor. Everything you own is at risk if your loan defaults, but that doesn’t mean there aren’t ways to protect yourself. In this article, learn what you’re really exposing yourself to, whether or not the lender has to go after the business first and how you can limit or cut off your liability.

In basic terms, a guaranty is a personal assurance to repay debt the business owes. Whoever signs on the guaranty promise is the guarantor and they can be the business owner or an outsider. When it’s the latter, they are called a third party guarantor.

Signing means that your personal assets are on the hook in the event the business does not pay up. In practice, that could mean: The lender will sue both the business and you. Then the lender will take the business assets. Then, if the lender is still owed money, it will come for you, and collect anything it can get from you: including your house, money in the bank, investments, and even garnished paychecks. Those personal assets will become collateral until the lender gets its due.

But do they have to try getting their money from the company first? Not usually. Unless otherwise specified in the financing paperwork, a lender is not generally required to try collecting from the business before it can collect from the personal guarantor. Most commercial guaranties are guaranties of payment, not of collection, meaning no duty to try the borrower first. Therefore, often the lender will sue the borrower and guarantor at once.

Caps the Guarantor’s Liability

Limited recourse financing is a lot like full recourse, except that it caps the guarantor’s liability at either a set dollar amount or a percentage of the loan amount.

Non-recourse Financing

With non-recourse financing, generally the guarantor is not liable for the lender’s losses, except for bad acts like fraud, waste, misrepresentation, bankruptcy or environmental contamination (carveouts). But that doesn’t mean you can skip out on your guaranty. If you do one of the bad acts that could result in the bank losing money, like fraud or environmental contamination, you’ll have to pay the lender. If the borrower has not committed any of those acts, then they are usually protected, and can hand over the property.

Protect Yourself and Minimize the Amount You Guarantee

Whatever the financing, you can protect yourself and minimize the amount you guarantee. That’s especially true when you’re not the majority owner: if you can’t control how the company manages the money or paying it back, getting a handle on your risk is critical.

If you own less than half of a business, here’s something you should know: It doesn’t matter that you don’t have control of where the company money goes, or what gets paid and what doesn’t. You could still end up on hook for a bank loan when the company blows through the bank account you’re not checking. You can, however, try to get a written agreement from the business putting its guaranteed loan ahead of other expenses, even owner payments, and get an indemnity for paying the loan. This means the business will have to cover anything you pay.

What happens when a loan has multiple guarantors? Many times, if a business loan has multiple guarantors, the lender can collect the full balance on the loan from any of those guarantors without pursuing any of the others or the business. Co-guarantors, beware. The guarantor paying can then seek reimbursement from the other guarantors (contribution). Consider a contribution agreement with co-owners which says they will pay you back for any money you have to pay the lender on a loan for the business. But the law around contribution is murky and depends on where you live. There may also be tax implications of these allocations of loss.

The tax issue is most likely to happen when the borrower is a partnership or a LLC taxed as a partnership.

Some guarantors back only a portion of a loan and are called partial guarantors. Others are called full guarantors and are liable for all of it. Even if you aren’t the full guarantor on a loan, you could still be liable to pay part of it if the business can’t. So what are your options for limiting the amount you owe?

One option is a guaranty of collection, which means that the lender has to get a judgment against the business first before going to the guarantor. If the lender does that and it comes up empty-handed, then they can chase the guarantor. Sample collection-only clause: The Guarantor(s) shall pay only after there has been a return unsatisfied of execution issued on a judgment against the business. In addition, the lender may have to liquidate all of its collateral before making a claim on the guaranty.

It is possible that a personal guaranty will end even after you have signed it. The guarantor and lender can agree to revoke the guaranty in writing, and some terms may include a guaranty expiration date or dollar limit. And bankruptcy can discharge your duty to pay some debts as guarantor.