A personal guarantee is just what it sounds like: a person guarantees to pay the lender if the business defaults. Typically the guarantor is an officer of the borrowing company or an individual with an interest in it, and the agreement is written. The most obvious example of a guaranty is one executed by the owner of a small business company, guaranteeing a bank’s loans to the company. If your company borrowed from a bank or a commercial lender, there is a good chance you signed one at closing, right alongside the note and the security agreement.
Why do lenders insist? The typical small borrower is an LLC or a small corporation that is thinly capitalized, with few assets and most of them already pledged, so its promise to pay means little if the company doesn’t have money to pay. For that reason, the bank will want someone to stand behind the loan of the small borrower and promise to pay. That’s what the guaranty accomplishes. Lenders need that personal guaranty as a backstop. When it is signed, it means that the guarantor is putting himself or herself on the line for the business: if the business can’t pay, the guarantor will.
In legal terms, a guaranty is a promise to answer for someone else’s debt if that party fails to pay, and the lender doesn’t look to the guarantor to pay the debt unless the borrower defaults. It depends on the loan existing, but it is a separate, independent obligation. Put simply, you really have two debts, not just one. The principal debt is the debt to the creditor, and then there’s your promise to pay it in case the borrower doesn’t. This is not a complex distinction, but the consequences are not always obvious.
Enforce a Guaranty
The most common form of guaranty is the “unconditional” and “absolute” guaranty. These are virtually synonymous. That means that the bank can call on the guarantor immediately to pay the debt upon a default, and without having to go after the company first. No magic words are needed; a guaranty is unconditional as long as it puts no limits or conditions on the lender’s rights. The creditor does not have to make any effort to collect money from the company before suing the personal guarantor, because the guaranty never placed that burden on the creditor. All the lender needs is a default by the company, which is usually easy enough to show.
What does the lender have to prove to collect from you? Massachusetts is a good example, and the list there is short: the loan, a written guaranty you signed, consideration, a default, the lender’s own compliance with the documents, and a balance still unpaid. In this context, consideration means simply that the lender gave something of value to the borrower in return for the guaranty. For example, the loan money it advanced to your company is enough. Read that list as the owner who signed and the first thing you notice is how easy it is. Lenders can sue you immediately after the company defaults.
Being able to enforce a guaranty is the real attraction for a bank. If a lender can’t enforce it, there’s no point in collecting it. That is why courts matter so much here, and in Massachusetts they lean hard toward the lender. A guaranty is read strictly, by its plain words, because guaranties were meant to be taken seriously. Judges treat these as deals between sophisticated business people and enforce them as written, partly to keep loan transactions certain and partly because if a creditor had no recourse against a guarantor, the offer of credit would dry up. Put plainly, they hold guarantors to what they promise, even if their words seemed too strict. So when an owner tells me the bank got the guaranty wrong, I usually ask whether that is what the document says. If it does, it matters little that the guarantor doesn’t like it, he had his chance to negotiate. If you sign a guaranty, it is what it is, and your obligation will be enforced. This is usually a surprise to the guarantor, but the guaranty doesn’t lie - it does exactly what it says.
Waiver Section
Then there is the waiver section, which almost nobody reads at closing. If you have ever signed a standard commercial guaranty, you have probably signed a waiver of notice section. Many guaranties go further, and by signing the commercial guaranty, the guarantor is giving up the right to raise certain “lawsuit defenses.” Claims and counterclaims are often waived too. Lenders include it because it makes enforcement easier: by agreeing to waive certain defenses and claims in advance, the guarantor essentially gives up some of the rights he might otherwise have had against the lender. Courts generally enforce those waivers, reasoning that you have knowingly given up rights you would otherwise have as a guarantor, whether related to notice or other matters. It’s a boilerplate provision, but a very important one to the lender.
Many owners also assume they can turn the bank’s treatment of the company against it. Usually they can’t. The reason is simple: the guarantor didn’t sign the loan agreement. The guarantor signed a guaranty, and that gives the lender a separate path to you. One Massachusetts court called guarantors “contingent creditors” whose fortunes rise and fall with the business. In practice, a debt challenge or a dispute over the bank’s behavior by the borrowing company is a matter between them, and not a defense for a guarantor. Put another way, if the guarantor is sued for what the company owes, the guarantor can’t say, “I am not liable because the company has a counterclaim against the bank.” These are inconvenient results for some guarantors, but they are what you agreed to.
Creditors Expect
So what do creditors expect from a personal guarantor? In short, they expect you to pay. Once the company defaults, your job is to cover for the company. When the company can’t pay, the guarantor is next. When the business can’t repay the lender, the “personal” guaranty becomes a serious financial obligation.
There’s a line from the movie Tommy Boy: a guarantee is only as good as the man who writes it. Lenders read it the other way around. A guaranty is only as good as the person who signs it, so if you are the guarantor on a loan your business can no longer carry, the questions they ask are about you, not the company: what is your financial condition now? Do you have money or assets to pay the debt? How much equity is in your house? What about your investment accounts? Lenders are practical - can they collect from you? After all, you didn’t sign a guaranty to say “maybe.” You signed to say yes.
The first step is to read the agreement you signed, line by line, including the waivers. A better understanding of all the facts will lead to a better analysis of all the options. Uncomfortable as it may be, it is essential to know how a creditor expects you to perform under the guaranty and what options you have.
