PERSONAL GUARANTEES: An Anchor That Can Bring Down The Unsuspecting
Sunday, January 9, 2011 at 6:04PM 5.22.10
By: Stephen J. Nash
Nash Law Firm
nash@nash-law.com
Many participants in the real estate market have signed personal guarantees in the course of doing business. It may have been in connection with purchasing property or borrowing money for a business. At the time the risk did not seem great and it was just part of doing business. Today many individuals in the real estate world, even if they are doing well, are looking at their personal guarantee as anchors that may bring them down even they are otherwise doing well.
A Personal Guarantee – What’s the Big Deal?
A personal guarantee is an agreement that makes an individual liable for a third party's debt or obligation. One of the most common situations where a personal guarantee is found is when a corporation, limited liability corporation or partnership borrows money. The lender does not want to rely on a corporate entity that may have no assets and will require that the owners all sign a personal guarantee so that they cannot use the corporate shield to avoid having to pay the debt. Another common situation where a personal guarantee will be required is where the borrower cannot qualify for a loan and needs a third party to guarantee a loan.
Many guarantees were signed with little thought because there was no perceived risk, especially when real estate was involved. Why would they ever look to me to pay the debt when they can always go after the real estate that more than covers the debt? Of course, today we are learning that the assumption that real estate values will always rise or at least remain the same is not true.
What is even more troubling is that many of the outstanding personal guarantees were given in connection with a business that the person giving the personal guarantee is no longer involved in. Unless a release was given by the lender the mere fact that a person leaves a business does not relieve him/her of liability if they signed a personal guarantee. So even though that person obtains no benefit from the business and has no control over the business, the lender can still go after him/her if the business defaults on its obligations! Not a pleasant thought but it is a situation that many in real estate are facing right now.
If a person leaves a business and cannot obtain a release from the lender on the personal guarantee, another option is to obtain an indemnity agreement from the person buying his/her interest or from the other owners. While it will not stop the lender from knocking on your door, it will allow you to seek payment from the buyer of your interest or the other owners if the lender does seek payment from you. Of course, this will not provide much comfort if the person/s who gave the indemnity have no ability to pay.
Another important factor to remember when it comes to personal guarantees is that they are generally drafted so that the lender can go after all of the individuals who signed personal guarantees or the lender can seek payment of the entire amount from any one of the guarantors. While the lender is going to seek payment from all of the guarantors, as a practical matter, they will focus on whoever is most vulnerable to collection. That guarantor is now put in a position where he/she must go after his/her fellow guarantors to receive reimbursement for the amounts paid over his/her share.
Lessons Learned
The first thing everyone who has been involved in business should check to see what personal guarantees they have signed and what are the terms of the guarantee. Next everyone who has left a business in any manner should check to see if personal guarantees were signed, what are the terms of the guarantee, whether they were released from the personal guarantee by the lender and did the buyer of your interest or the remaining owners of the business agree to indemnify you if the lender sought payment from you.
If you have outstanding personal guarantees you must carefully evaluate the likelihood of default by the business, the value of the assets of the business, the remaining amount of debt, the financial situation of the others who signed guarantees, review the terms of the guarantee that you signed and evaluate what assets you own that are subject to collection.
If you are in a business or partnership that you or others may leave make sure you take into account the personal guarantees that were signed. Leaving a business without dealing with the personal guarantees that you have signed is like leaving a farm after stepping into a cow pie, while you may have left the farm the crappy part of the farm is still with you.
If you are asked to sign a personal guarantee you must review the terms of the guarantee to evaluate the risk you are taking. In most cases you will not be able to convince the lender to not require the guarantee you often can negotiate the terms of the guarantee. This is significant in that the guarantee presented to you most assuredly has been drafted exclusively for the benefit of the lender. Going into a business or into a purchase everyone looks at the potential upside but you are doing yourself a disservice by not evaluating the potential downside so that you can best protect yourself from the fall-out.