What is a personal guaranty?
A personal guaranty is a legally binding promise that a person will fulfill the financial responsibilities of another. They are generally used to protect lenders or other types of creditors. For example, many lenders require small business owners to sign a personal guaranty as additional assurance of repayment. As a result, the small business owner, in addition to the business itself, is responsible to pay the debt. Similarly, many businesses require a personal guaranty before providing goods on credit. For instance, a supplier may require a construction company’s owner to sign a personal guaranty that the owner will be personally responsible for paying the supplier back if the owner’s company fails to do so.
What are the risks of a personal guaranty?
Because a personal guaranty makes an individual personally liable, an individual should not sign one lightly. Nobody signs a personal guaranty with the expectation of being held personally responsible for the underlying debt, but it happens. For example, a business owner may have great confidence in his business and may personally guarantee a debt, but a change in the market, a legal dispute, or a number of unforeseen events may destroy the business, and on top of dealing with the loss of the business, the business owner—as a personal guarantor—now risks losing his personal assets as well.
Anything that the personal guarantor owns might be used as collateral to recover the unpaid amount. The individual’s cars, boats, vehicles, investment accounts, savings accounts, his kids’ college funds, toys, stamp collections, etc.—any personal property—may be at risk. Real property in the individual’s name can also be sold to satisfy the debt. A personal residence or second home may be at risk of being sold. Said simply, a personal guaranty places the individual’s and his family’s financial future at risk.
What are the benefits of a personal guaranty?
A new business without a track record or adequate assets may not be able to secure funding on its own; however, a lender will be more willing to extend a loan to an unproven business if the business owner has many assets and agrees to sign a personal guaranty. The business then has working capital and the ability to grow and create more wealth.
Sometimes, even when a business is well established, has many assets, and engages in a low-risk enterprise, a lender may still be reluctant to give the business a loan. A risk-adverse lender will often find comfort—and the assurance needed to move forward—if it has a personal guaranty. Or, the lender may be willing to extend the load on more favorable terms with the added assurance of a personal guaranty. So, a personal guarantee can be a helpful tool—that is, as long as the underlying debt is satisfied.
What are the different types of personal guaranties?
Generally, there are two types of personal guaranties: limited and unlimited. By signing an unlimited personal guaranty, the guarantor agrees to allow the creditor or lender to recover every cent of the underlying debt at issue, along with additional expenses that may arise from the unpaid debt, such as interest, attorney fees, and collection costs.
For example, let’s suppose that a personal guarantor agreed to satisfy the debts associated with his construction company taking $50,000 of material from a supplier to be used on a project. If the owner does not pay the construction company, and the construction company in turn is unable to pay the supplier, interest will begin to accrue on the $50,000. If the debt goes unpaid, the supplier may hire an attorney to recover the unpaid amount. Before you know it, with added interest and attorney fees, the $50,000 debt obligation can potentially double, especially if the personal guarantor refuses or is unable to pay the underlying debt.
A limited guarantee, by contrast, does not pose the same risk. They set a specific dollar amount that becomes the ceiling for the personal guarantor’s liability. For instance, in the above example, the personal guarantor may only agree to be responsible for $25,000 of the debt. More commonly, a limited guarantee exists when business partners take out a loan for their company. Each business partner’s portion of the overall debt is allocated among them (severally, not jointly), lessening the overall responsibility should their company enter rough times and find itself unable to pay the debt.
How can I get legal help regarding a personal guaranty?
Perhaps you have been asked to sign a personal guaranty, and you don’t understand what the strange words and legalese of the document means. It will be worth every penny to you—and to your family—to hire an attorney who can decipher the language of the personal guaranty and explain the risks and benefits of signing it. If you move forward without fully understanding the document you sign, you may find yourself on the hook for far more than you bargained for. An experienced attorney will be able to identify and explain to you problematic provisions of a personal guaranty, and he can also help you negotiate terms that you can live with—or give you the confidence to walk away from the proposed deal.
If you are a lender or business owner who is contemplating extending credit but wary of the debtor going into default, a personal guaranty may be appropriate. For example, if you are considering extending credit to an unproven business, a personal guaranty signed by the owner may motivate the owner to repay the debt, but if all goes south, you’ll have the assurance that he is personally responsible for the debt. Whatever the case may be, an experienced business attorney can help you draft a contract and personal guaranty to account for your concerns and minimize your risks.