One of the main selling points of doing business as a limited liability company or corporation is that your business debts stay at the business and don’t make it back to you personally. Except that most lenders don’t take the LLC or corporation on faith. They want you to sign a personal guarantee for the loan, which is a contractual way around the whole limited liability thing. A personal guarantee is a written contract that you have signed or that you gave someone else authority to sign on your behalf, and it means you will pay if the business defaults.
You’re in the meeting, the credit rep slides a guarantee across the table, and your heart rate jumps. Can you put limits on what you are about to sign? The simple answer is: yes, you can usually negotiate limits before you sign. The truth is, the fine print controls. The specific clauses in the guarantee determine whether your personal liability is a soft nudge or a hard shove, and what follows are the clauses to watch and the asks to make.
Why do lenders want guarantees? The point of it is to give them more eggs to collect with, and to signal that you consider the loan repayment your number one job because you’ve got your home and your paycheck on the line. More often than not, it’s a step you take because that’s the risk you have to accept to get the loan. If the business never misses a payment, the lender has no incentive to enforce the guarantee even though they could. If the business does default, the lender can enforce the guarantee to collect from your personal assets and earnings.
Look carefully for language making you “directly and primarily liable,” because then the lender doesn’t need to wait for the business to default before turning on you. It’s as if you had gone to the bank yourself as a borrower. Everything in the agreement is worth reading, and many terms are negotiable, even for a fledgling company with nothing on the balance sheet.
And then there’s the “continuing guarantee.” A guarantee might cover a single loan only, but lenders like to propose a guarantee that lasts indefinitely. It covers every debt the business owes to that lender at any point, including any renewals or extensions, even debts that existed before you ever owned a share of the business, plus any new loans the lender might make to the business after you no longer own any part of it.
A continuing guarantee doesn’t end just because you want it to. It ends only after you have sent the lender written notice of termination in compliance with the precise terms of the agreement. By contrast, a guarantee that attaches only to one loan usually terminates when that loan is repaid. The risk is that an owner will pay off the loan, sell the business, forget the guarantee, and then find they are still on the hook for the new loans that the business might take on later. The termination of a continuing guarantee applies only to new debts incurred after the termination date. You remain liable for the full existing balance with interest and fees until that is repaid.
Unlimited and Limited
There are two broad types of guarantee: unlimited and limited. An unlimited guarantee has no cap on the amount or the time, so you’re on the hook until the loan is paid in full. A limited guarantee limits your risk in some way, whether by a dollar cap or a specific date, or by restricting the guarantee to particular loans. In its simplest form, the guarantee states that your liability won’t exceed a specific amount that’s lower than the full loan balance. The amount you get will depend on how much leverage you have in the negotiation. Too many owners simply sign the first draft without pushing for better terms.
Multiple Owners
Let’s say your business has multiple owners. The best scenario is that each one signs for just his or her slice of the loan, not the whole amount. Ask for a clause that says every owner’s share is at least as big as their ownership stake. A lender might counter by asking the total of those slices to sum to more than a hundred percent, in case one owner bails and the others need a cushion.
It’s a lot easier to borrow when more people sign the guarantees, but that doesn’t mean each one only owes a piece. For example, four people might sign unlimited guarantees for a company they started together, and that doesn’t mean each person guarantees only 25%. Most guarantees use the phrase joint and several. In some states (like North Carolina) the law says that’s what any guarantee means even if it doesn’t say so explicitly. The lender can go after any one guarantor for the full amount, or a couple of guarantors, and then those owners have to sort it out between them.
If one co-guarantor goes bankrupt, is released by the lender, or just vanishes, the remaining guarantors still owe the entire amount. You can’t force the lender to collect part from someone else, but if you end up paying more than your share you can claim “contribution” from the others. The law treats every guarantor as having implicitly promised to chip in his portion, and being left out of the lender’s lawsuit doesn’t relieve you.
Difference Between Guaranteeing “Payment” and Guaranteeing “Collection”
Not all guarantees are created equal. There’s a difference between guaranteeing “payment” and guaranteeing “collection.” A payment guarantee lets the lender come straight to you without first trying to get the money from the business. A collection guarantee means the lender has to go after the business first and only can approach you after they’ve chased all their remedies. Almost all form documents use the word “payment,” and lenders don’t like to change to “collection” unless you have a bulletproof case. But if you’re on the other end of a good loan to a healthy, profitable company, you might be able to negotiate for “collection.”
Watch out for a right of set-off clause in your guarantee. If you sign, the lender can automatically grab whatever is in any of your accounts it holds, including ones you open after the loan is signed, to pay off the business’s missed payments, and it doesn’t have to tell you first. The only exception is certain IRS or trust accounts. This is the document that lets the bank take your personal money out of your own bank.
If a guarantor dies, most guarantees still stand. Their obligation passes into the estate, and the only ways to break it are by paying the debt in full or getting a release from the lender. Lenders don’t give up their security lightly, so they rarely agree to release the estate unless someone acceptable takes the place of the deceased guarantor. You can try to negotiate a release-on-death provision (or a release-and-replacement provision) in some circumstances, but such provisions are detailed and complex. They should be drafted by an attorney or other professional.
When a lender asks you to sign a guarantee, read it line by line and make sure you understand what you are agreeing to. Ask for a cap; limit it to a specific time; apply it only to specific loans; share it among owners on a percentage basis; require that the lender try to collect from the borrower before asking you to pay; make sure the lender can’t apply a set-off provision against the guarantee; and understand how to terminate a continuing guarantee. Know your own leverage before negotiating; the worst thing you can do is sign the lender’s first draft without asking.
