You Signed and No One Else Did
It is a question we hear often at Delancey Street from owners of businesses with more than one partner. First, loans often require one or more owners to ”guarantee” the loan. In this situation you signed and no one else did. That means if the company is struggling, the lender can ask you to pay. The business may belong to all of you, but the demand letter has only your name on it.
Once a guarantor pays a debt, in this case the loan, they have a right to reimbursement (recourse) from the party that actually owed the debt. In this situation, it is the business that borrowed the money. However, if a business has defaulted on its loan, there is a good chance the business would not have the financial ability to pay.
Also you’ll sometimes hear of ”contribution.” That is, if two guarantors have agreed to take the debt together, and one pays it all, the other can be asked to contribute their share. But in your situation, only you were a guarantor. The others aren’t “guarantors,” so contribution law as you might be familiar with it doesn’t come into it for you. That does not mean your partners can never be asked to share the loss. It means the answer is not handed to you by the rule that governs co-signers.
A Three-member LLC
It helps to see how contribution works when several owners do sign, because it shows how little the default rules care about who owns what. Say you have a business that’s a three-member LLC. The members have ownership interests of 60%, 30%, and 10%. The LLC borrows $3 million from a bank to purchase a piece of commercial real estate and the bank takes a mortgage on the property. The bank is understandably cautious and requires all three LLC members to jointly and severally guarantee the entire loan. Unfortunately the business does not do so well and the loan goes into default. The 10% owner ponies up and pays off the entire balance. And then she goes looking for her partners to reimburse their fair shares. Here’s where it gets interesting. In the absence of an agreement to the contrary, the default rule (subject to many exceptions and qualifications) is that all guarantors settle up so each pays an equal share of the loan, even though the partners’ interests vary widely. In our example, each member would bear one-third of the loss. This situation often surprises business owners who are not aware of this general rule and might have worked out an alternative among themselves if they had contemplated the possibility.
No Co-guarantor to Settle up With
Now notice what that rule depends on: other people who signed. When you are the only guarantor, there is no co-guarantor to settle up with. What if some of the owners did not sign a guaranty, but it would be reasonable to expect them to contribute? That is exactly the kind of question the business owners should have settled up front. How are they going to divide the loss if the company can’t make payments?
The owners can agree on a written contribution agreement covering the issue. If you and your partners sit down to write one, the list of questions is longer than most owners expect. Does the general rule apply, or should they split up the contribution by ownership percentage? Are spouses one or two guarantors? Is interest due on amounts paid, and at what rate? What if one of the guarantors is insolvent, deceased, or not reachable? What if the guaranties were capped, so that each guarantor was not responsible for the entire loan? What if the guaranties have a ”bad acts carve-out” provision, and one owner caused the act that triggered liability? What if one owner has paid the balance when the others believe that there are viable defenses? What if one of the guaranties was legally defective? Which state’s law should apply? And should one person carry the whole loss and fully reimburse the others? Someone who owns nothing in the business but guarantees a loan as a favor to a relative who owns it, and who also signs, might expect that relative to pay them back in full if the guaranty is called.
Without a written agreement the answers can be unpredictable and different depending on the state, and then, there are the federal income tax consequences for a partnership, or LLC taxed as a partnership. These issues come up any time you have several guarantors or parties who provide collateral for the same debt.
The important point is that contribution agreements should be signed before problems arise. If none of your partners have signed a contribution agreement, the time to review how you’ll split the loss together is now, with an attorney if need be. Delancey Street is a business debt settlement company based in New York City. We are not a law firm, and when litigation, bankruptcy or tax work is the right call, we will refer you to an independent attorney vetted for the particular area of practice. Our senior business advisers negotiate with merchant cash advance funders, lenders and other creditors for less than the full amount owed. We are not lenders and do not sell you another loan. We have a policy of free and confidential first consultation.
