When is a personal guarantee on a business loan unenforceable?

Getting the required funding is one of the hardest obstacles facing a new business. Sometimes a bank will press an owner for collateral but if the business is short, sometimes the best that can be arranged is a personal guarantee. Lenders will try to collect on those guarantees, but in certain circumstances they cannot be enforced.

A Guaranty Agreement

A guaranty agreement is a contract where one party agrees to assume the debts of another on default. The most typical example might be a parent or other family member co-signing a loan for a car or to finance a student loan. The individual making the guarantee is referred to as the guarantor. Sometimes, a guaranty agreement is called a “Personal Guaranty” when an owner backs a bank loan for his or her business.

Signing a guaranty means the guarantor becomes personally liable for the amount of money the business owes. A guaranty normally kicks in if the company is not able to pay its creditors as required.

Here is a typical example:

• A company needs to buy machines to make and sell widgets.
• The company borrows the money from a bank. The bank receives a security interest in the machines that it can claim if the loan is not paid. The loan may also demand that the owner give his or her personal guaranty that the money will be repaid.
• Suppose the business fails, doesn’t sell enough widgets and so misses payments.
• The bank sues for default on the loan, and also names the owner individually for breach of the personal guaranty.
• The owner owes the gap between what the collateral sold for and what the balance due is.

Your Own Personal Assets

Say you did back up your corporation with a guarantee, but the company closed. You’d then have to pay your business debts with your own personal assets. These can be a current house, checking account, savings, and investments. Worst of all, the lender may garnish your paycheck.

There are some specialized insurance products that may cover all or part of these losses. Ask your insurance agent.

Unable to Enforce Personal Guaranties

A personal guaranty can show up in a lot of different business contracts. It pays to be aware of the consequences and protections before you sign one. Sometimes, even big banks are unable to enforce personal guaranties because they skipped the basic requirements.

A guaranty must be in writing

Ohio Revised Code 1335.05 requires that a guarantee be made in writing. When you are confronted with a demand letter for payment, always ask for a copy of the document that you signed. Whoever enforces a contract always has the burden of proving it exists.

You must sign as yourself

To be binding, a guaranty must be signed in the name of the person making it. You might be tempted to sign with your corporate name or as President, CEO or another corporate title. Do not. It is important to understand that a signature in a corporate capacity for a company binds the business only.

There must be consideration

Having a signed and binding agreement still does not mean that you are unable to defend against a guaranty. A personal guaranty is a contract, and must meet all of the normal requirements for all contracts to be enforceable. No contract is enforceable without adequate consideration. Consideration is a technical legal term meaning something of value passed from one party to the other. Often that means a lender has lent the business the money that has been promised to be repaid.

Even then, creditors sometimes can’t prove their right to collect because they can’t prove the paperwork exists. Loans may get repackaged, resold, and resold again, and the documents get lost.

But even a valid guarantee can end. One way that a guaranty can become unenforceable is if the guarantor and lender both agree in writing to revoke it. A bankruptcy proceeding can wipe out some, but not all, guarantor debts.

Because there can be so many factors deciding whether a guaranty can be enforced, it’s hard to predict the final outcome.