When you own a business, your business loan will likely be guaranteed by you personally. When the business fails to pay, the lender will almost certainly attempt to recover the outstanding balance on that guaranty. But the reality is that you’re the weaker, softer target. The business might be dead, and your primary asset might be your home. The bank’s going to lean on you.
A personal guaranty is just a promise to personally pay the business loan if the business doesn’t pay it. The person guaranteeing it is the guarantor. Usually it’s the business owner, but sometimes it’s a third party. We’re talking about an agreement where you agree that if the company doesn’t pay, you will. With a guaranty, the creditor can come after the personal assets of the business owner(s) in the event that the corporation defaults.
When a Business Defaults
When a business defaults, the lender will sue both the business and you (the guarantor). The lender does not have to sue the business before they sue you. It’s very likely that you are giving a guaranty of payment rather than a guaranty of collection. With a guaranty of payment, the guarantor is liable the minute the debtor defaults, without the bank needing to take steps to get paid from the debtor first. A guaranty of collection is not binding until the creditor has exhausted its other remedies. Most commercial guaranties are the first kind, so expect to be named in the same lawsuit as your company. If there are insufficient assets in the business, the lender will go after any of your personal assets, like your home, checking account, savings account, investments, future earnings, and possibly garnish your paycheck.
If you signed alongside partners, the bank can pursue 100% of the outstanding debt against any one of the guarantors, not just your share. Which one? Well, whichever one that the bank wants to pursue. Any guarantor can recover a share from other guarantors who are business owners, but the rules are unclear and vary by state.
Not every loan exposes you to the full balance. There can be limited recourse, or non-recourse, to a guarantor. Limited recourse means the guarantor is only on the hook for an amount capped at a specific dollar amount or percentage. Non-recourse means the guarantor is only on the hook for some “bad acts” (i.e., “carveouts:” fraud, misrepresentation, waste, bankruptcy, environmental contamination). A non-recourse guaranty means that in the event that the business is unable to make payments on the loan or pay at maturity, it can simply turn over the underlying property to the lender and the guarantor does not owe anything, provided that the guarantor has not violated one of the “carveouts” to the non-recourse guaranty.
Ways to Limit That Exposure
As a guarantor you will have little ability to control how the business spends its money or how it prioritizes payments. Thus, if you are a minority owner, you may end up picking up the tab for a substantial business loan. There are several ways to limit that exposure. First, you should insist that the business enter into a written agreement obligating it to repay any loans you guarantee first and before paying any expenses, especially payments to the other owners. Second, it should also enter into an indemnity agreement that says that it must reimburse you for any money you pay the lender on the guaranty, which means the business will hold the minority owner harmless for any loan monies he or she is forced to pay.
Third, if you are entering into a guaranty with another owner or owners, you should get an agreement among the co-guarantors as to how any losses or contribution from you will be handled. Remember to consider the federal income tax consequences of your involvement. This is especially true if the borrower is a partnership or an LLC taxed as a partnership.
Fourth, you should consider entering into a partial or limited guaranty. For example, the guarantor can agree to guarantee the loan on collection only so that he or she only has to pay if the lender cannot recover on a judgment after it has been obtained against the business. This guarantee could also only apply to the balance remaining after the collateral for the loan is sold.
Can a Guaranty Be Undone After You Sign It
Can a guaranty be undone after you sign it? Because a guaranty is a contract, it is bound by its terms. The lender can release the guarantor from the guaranty with a mutual written agreement. A guaranty can also be written to sunset after a certain time period. It might also only be for a certain amount or percentage. And some debts owed by guarantors can be discharged in bankruptcy.
If you are facing a default on a loan you personally guaranteed, the worst thing you can do is ignore it. Read your guaranty, learn which kind you signed, and get help before the lawsuit lands.
