For business owners, a common aspect of doing business is a request by a lender, the landlord or vendors for the owners to personally guarantee the debts and obligations of the company. From the creditor’s perspective, it provides additional assurance that the debt will be paid. From the business owner’s perspective, it may be necessary to close a deal or to obtain financing. However, not all business owners understand the legal significance of the personal guaranty. In many cases, owners are so eager to obtain financing, and so confident that their businesses will succeed, that they ignore the potential repercussions of the guaranty. Owners need to understand that the failure of a business, backed by a personal guaranty, can have a devastating effect on the business owner’s personal assets.
Most personal guaranty agreements are wordy documents with complex legal terminology. In most cases, the “guarantor” is agreeing to be responsible for the entire debt if the business defaults. In some cases, the guarantor may only be responsible if the creditor exhausts all collection remedies against the business first (in such case, the guarantor is called a “guarantor of collectability”). Generally, the creditor can pursue both the business and the guarantor in the same legal action, and obtain a judgment against both as jointly and severally liable, which means the creditor can pursue either party for all or part of the money owed.
If a creditor obtains a judgment against an individual owner based upon the guaranty, the creditor can enforce the judgment against the personal assets of the business owner. Methods for collection include garnishment of bank accounts and income, as well as a forced sale of real and personal property. Depending on the size of the debt, the business owner may have no choice but to seek bankruptcy protection to stop the collection process.
What should a business owner do when asked to sign a personal guaranty?
First, a business owner should fully and carefully read the guaranty and consult with an attorney about the implications and consequences. Second, a business owner should assess the risk of the personal guaranty with consideration to the following factors:
(a) the debt involved;
(b) the financial strength of the business and likelihood of continued success;
(c) the potential impact on the business owner’s personal assets in the event of default by the company; and
(d) the titling of the business owner’s principle assets such as the residence and brokerage accounts. Next, a business owner should attempt to avoid, or negotiate more favorable terms for the guaranty, such as a limitation of the guaranty to a maximum dollar amount, or alternative arrangement (i.e. secure the debt against the assets of the business or a letter of credit).
A business owner should never sign the guaranty without considering the consequences on the assumption that it is just a part of doing business.
In another article we will discuss how to protect your personal assets.