Personal Guarantees: Instruments of Personal Financial Destruction

Lending institutions often ask or require owners of privately held businesses to personally guarantee their businesses’ loans. When a business has multiple owners, the bank may obtain personal guarantees from all the owners, and occasionally, even their spouses.  While these arrangements may seem reasonable or even necessary when obtaining financing, personal guarantees can be ruinous if not adequately negotiated or understood.

Recently, we’ve seen co-owners with personal guarantees leave businesses that subsequently fail. Unfortunately, the now-former owner does not realize that standard loan guarantees—including his—are drafted by lenders to be “continuing” in nature, meaning that the owner will continue to be liable not only for the underlying loan, but also for any renewals of the loan, and also for any further extensions of credit to the company by the lender.  Short of full repayment of all loans with the lender, the guarantee continues indefinitely.  Moreover, the former owner’s liability continues despite the fact that he is no longer involved in the underlying business, and may have no ability to control or even monitor the business’s finances.  It may be years after leaving the business before the former owner first learns that the business is in dire shape and the lender comes after him to collect.

While lenders are often willing to negotiate settlement of the owner’s guarantee, and asset protection planning can in some cases shield the owner, in all events the owner must usually proffer a substantial outlay to the lender.  Often, these hapless owners were frozen out by their former business associates, and end-up footing the bill when those associates squander the company’s assets.

We strongly recommend careful review of any guarantee language when negotiating a business loan.  Frequently, lenders ask for guarantees as “icing on the cake” that are nonessential to the making of the loan.  If the lender is unwilling to extend a business loan without some sort of surety by the owners, it may be advisable for the owners to consider signing the note itself rather than a guarantee, as an owner’s liability will terminate if and when that note is rolled over or paid off.

Disclaimer: This article is provided for general informational purposes only and is not legal advice.

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