Having access to credit can be essential for a new business to survive and grow, yet lenders are not always willing to extend credit to businesses that do not already have a well-established credit history without a personal guaranty. While a personal guaranty can help a business obtain credit, it poses personal financial risks to the owners, who are typically the guarantors. Before signing a personal guaranty, a business owner may want to speak with an experienced attorney to discuss the risks and benefits. If you are asking, “What is a personal guaranty?” or considering signing such a document, consider contacting an Arizona business lawyer at Harrison Law, PLLC, by calling (480) 320-2310 to schedule a consultation.
The Personal Guaranty
A personal guaranty is a legally binding promise made by an individual to repay a loan provided to a business if the business is unable to pay the loan itself. A personal guaranty is included as a provision in a business loan agreement and may be applied to all types of business loans, including loans backed by the United States Small Business Administration, property and asset leases, and mortgages. Personal guaranties are often required by lenders as a qualification requirement for businesses that are not well established or that have a poor or inadequate credit history. A personal guaranty, serves to mitigate the risk faced by the lender in providing credit to the business. In addition, lenders may also provide more favorable loan terms even to well-established businesses with a strong credit history if a personal guaranty is provided as part of the loan application.
A personal guaranty is signed by business owners or partners who become guarantors or co-signers on the loan. This means that they are agreeing to repay the loan from their own personal assets if the business is unable to repay the loan itself. While this does pose significant risk to their personal financial future, business owners are typically heavily invested in the success of their business and, therefore, may be willing to take this risk to obtain the financing their business needs to succeed.
Types of Personal Guaranties
According to the United States Census Bureau, there were more than 5.4 million applications filed to form new businesses in 2021, the highest number of any year on record. These new businesses may need to make a personal guaranty. There are two types of personal guaranties that differ based on the following:
- The extent of liability placed on the guarantors
- The term of the guarantee
Unlimited Guaranty
An unlimited guaranty means that the business owner is liable for the entire outstanding balance if the loan defaults. This gives the lender the legal right to recoup the balance of the loan plus interest or legal fees using the business owner’s personal savings, retirement accounts, vehicle, home, and other assets.
Limited Guaranty
A limited guaranty limits the proportion or dollar amount of the debt for which a guarantor is liable. This is commonly used when there are multiple business owners or partners to provide a personal guaranty, allowing the lender to collect a portion of the debt from each guarantor if the business defaults on the loan.
The two types of limited guaranties, which determine the extent of a guarantor’s liability if his or her business partners do not pay their share, are as follows:
- Several guaranty—Under a several guaranty, each guarantor has a fixed proportion of liability. If the business fails and one or more of the partners do not have sufficient assets to pay their share of the loan, the remaining guarantors are only legally required to pay their predetermined percentage or dollar amount of the loan.
- Joint and several guaranty—Under a joint and several guaranty, each guarantor can be held legally responsible for the entire amount of the debt if one or more of the partners does not pay their share.
How To Reduce the Risk Involved in a Personal Guaranty
A personal guaranty poses a certain amount of risk to the guarantor. To reduce this risk, it is important to understand the clauses and language contained in the guaranty.
Know Exactly What Type of Guaranty Is Being Signed
The type of guaranty determines the extent of the guarantor’s liability in the event that the business defaults on the loan. A limited guaranty provides greater financial protection than an unlimited guaranty. Any clauses related to a joint and several guaranty could mean that any individual guarantor would become fully responsible for the outstanding balance of the loan, even if other business partners also signed a personal guaranty.
Be Wary of “Bad Boy” Provisions
A “bad boy” provision may be included in a limited guaranty to allow the lender to convert the guaranty into an unlimited guaranty if certain “bad boy” events take place. This provision serves to protect the lender against specific potential unethical or illegal actions on the part of a borrower. However, this type of provision can also result in a guarantor becoming personally responsible for the entire outstanding balance of a loan.
Understand Everything Contained in the Guaranty
Financial contracts contain a great deal of highly complex information. Unfortunately, people commonly skip over the fine print and sign documents in haste. In the case of a personal guaranty that poses significant risk to personal finances, however, it is critical that guarantors understand every detail of any contracts they are signing.
Assessing your risk when signing a personal guaranty requires understanding the contract and its provisions and clauses. An experienced business attorney from Harrison Law, PLLC, may be able to help business owners find the answer to, “What is a personal guaranty?” and evaluate the associated risks and benefits.
Alternatives to a Personal Guaranty
A personal guaranty is one option for a lender to mitigate the risk in providing credit to a business. There are other ways a lender can secure a loan that may reduce the personal financial risk posed to business owners, including:
- Collateralized loans
- Blanket business liens
Collateralized Loans
A collateralized loan allows a borrower to offer up specific assets as collateral to secure a loan. If the business defaults on the loan, the lender may obtain a court order to seize the assets from the business or its owner to liquidate them for cash to repay the loan. A collateralized loan provides greater financial protection to a business owner than a personal guaranty since not all personal assets are at risk.
Blanket Business Liens
A blanket business lien acts in the same way as a personal guaranty, but it only takes a claim on the business’s assets. If a business fails or is unable to repay its debt, a lender may file a lien for unpaid debts with the court to obtain the right to liquidate the business’s assets and collect the cash needed to repay the loan. In effect, a blanket business lien can cause a business to become bankrupt, but this option poses less personal financial risk to business owners. However, many loans that contain a provision for a blanket business lien also require a personal guaranty. If the assets belonging to the business itself are insufficient to repay the debt, the lender can then access the business owners’ personal assets for repayment.
Contact an Experienced Business Lawyer for Help Today
Signing a personal guaranty gives a lender legal claim to certain assets, which may include personal bank accounts, retirement and investment accounts, vehicles, and homes. Therefore, understand the terms of the personal guaranty and the risks involved before signing it. If you are asking, “What is a personal guaranty?” or assessing the risks involved in signing one, consider contacting an experienced business attorney at Harrison Law, PLLC, by calling (480) 320-2310 to discuss your options.
© 2022 Matthew W. Harrison and Harrison Law, PLLC All Rights Reserved
This website and article have been prepared by Harrison Law, PLLC for informational purposes only and does not, and is not intended to, constitute legal or financial advice. The information is not provided in the course of an attorney-client relationship and is not intended to substitute for legal advice from an attorney licensed in your jurisdiction.
