A lot of lenders are competing hard for the good middle market borrowers these days. So more and more lenders are accepting limited guaranties from the owners of borrowing businesses. Owners demand that the lenders accept the limitation.
However, if the guaranty is limited, the lenders need to define and measure its scope very carefully, and usually at the term sheet or commitment letter stage.
A limited guaranty is harder to get a fix on than an unlimited one. In the unlimited case, each owner is liable for the entire balance of the loan. A limited guaranty only runs to an agreed dollar cap, or sometimes to an ownership percentage, and that means the lender has to do a lot of math and monitor to find out what is guaranteed and what is not.
Jointly and Severally Liable
In an unlimited guaranty, the guarantors are usually jointly and severally liable. That means that each guarantor is liable for the whole debt, and that there is only one debt. The lender may collect the entire amount due from any one guarantor or any combination, but only once. If one guarantor pays it all, the others are released.
Say the loan balance is $1,000,000 and the two owners both give limited guaranties for $500,000. If they are joint and several, the guarantors are not responsible for half the loan each. Instead, the owners are both released once what they pay adds up to $500,000. If the lender pursues one owner, it collects the entire $500,000 from that owner, and the other is out of the woods. It is key here that the lender and the owners know and agree on just what the guaranties cover.
Often, lenders expect to “stack” the guaranties, so that the lender is guaranteed $1,000,000. The risk is twice as great if the guaranties run up to $500,000 several, but not joint. In that event, the lender may collect the $500,000 from one or the other, or from both. Because of that, each owner may have to pay $500,000, so $1,000,000 is at risk. Here, the word “several” with no mention of “joint” doubles what the owners risk together.
Spell Out Each Owner’s Obligation
The lender’s loan committee or C-level should determine all of these matters and spell out what they decided in the term sheet or commitment letter, before the applicant starts to work on and pay for preparing the final papers. If someone tries to add a joint and several or several only guaranty at the last moment, the owner will be caught short. There may be a last-minute negotiation over the guaranties, and that can lead to delays, a failed closing, and ill will.
The borrowers and their counsel must review the draft of any form guaranty carefully. Many lenders draft their guaranties in joint and several terms, which if used in a limited guaranty can quietly defeat the stacking.
Guaranty of Collection
If the loan goes bad, the lender may have a claim against the borrowing business, and also a claim against the owners who give guaranties. In this situation, the owners may ask for a guaranty of collection, also called a guaranty of marshaling or deficiency. A guaranty of collection is an agreement by the lender to go after the business and its assets before turning to the owners. Many lenders balk at this. They argue that it takes too much time to sue the borrower or foreclose on collateral before they can turn to the guarantor. This restriction could seriously delay the collection and impair the value of the guaranty. Some lenders also demand that guarantors guarantee payment, not just collection. That would put the guarantor on the hook whenever the borrower fails to pay.
Whatever kind of guaranty is given, sometimes the lender and the owners will fix on a limit for the guaranties and find out what that means only when there is a default or litigation over the guaranties, at the end. That is just the opposite of where it should be. It is better to talk about all this and nail it down in the term sheet or commitment letter. Evaluating all of these terms early, before the lawyers start to spend time on the legal papers, will make any financing go more smoothly, and minimize the chance of error and confusion. There are fewer chances of a last minute conflict that could sour the relationship between lender and borrower.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
