Personal Guarantees are a very important part of many business contracts. Its no wonder I spend a lot of time advising clients on this issue. This article will explain six basic concepts of a personal guarantee (sometimes spelled guaranty).
Business Contracts In General.
Most business contracts are agreements between companies, not between individuals. For example, the parties to a commercial lease are the landlord (Company A, LLC) and the tenant (Company B, LLC). The individual owners of those companies are not parties to the contract and are not obligated to do anything under the contract. Instead, it is their companies that are entering into the contract; only the companies are liable if there is a breach of the contract. For example if Company B breaches the lease by not paying rent, Company A can sue Company B, but Company A cannot sue the individual owners of Company B, because the individual owners were not parties to the lease agreement. If Company B has little or no assets, it is unlikely Company A will be able to collect anything from Company B.
1. What Is A Personal Guarantee?
A personal guarantee is a part of a contract, or sometimes an entirely separate contract, where an individual person agrees to be personally liable for a contract in the event their company breaches the contact. In most cases, the individual owners of a company would serve as the personal guarantors, but a non-owner third party could also be a guarantor. It depends on what the other party to the contract wants in order to feel comfortable that they will be made whole in the event of a breach of the contract.
2. When Is A Personal Guarantee Requested?
A party to a contact will request a personal guarantee when they have doubt the company can meet its responsibilities under the contract. These doubts might exist if the company is new, or the company has a record of not meeting its obligations in the past. The personal guarantor is essentially co-signing the loan for the company. This is just like co-signing a loan for a relative. For example, your brother might have bad credit and a car loan lender might be worried that your brother won’t be able to make the payments. Therefore, the lender might require you to co-sign the loan for your brother before they will approve the loan.
3. What Liability Do You Assume When You Sign A Personal Guarantee?
When an individual personally guarantees a company’s performance of contract, that individual is assuming responsibility to make the other party whole in the event the company breaches the contract. For example, if a tenant to a commercial lease cannot pay its rent, the individual personal guarantors are responsible for paying the rent. If the lease is breached, not only can the landlord sue the tenant for unpaid rent, but they can also sue the all of the individuals that personally guaranteed the lease agreement. Therefore, not only can the landlord go after the assets of the tenant, but they can also go after the assets of the individual personal guarantors, including their home, bank account, wages, investments, etc.
4. Do They Have To Go After The Company First?
Typically not. This is one of the most common misconceptions I hear from my clients. If a contract is breached, the other party to the contract can sue the personal guarantors right away. They do not have to exhaust all remedies against the company before they can go after the guarantors. If the company is small and has assets of little value, the other party probably won’t even try to collect from the company. They will go straight for the personal guarantors because it is typically much easier to collect against an individual than to collect against a small company.
5. How Do You Avoid A Personal Guarantee?
This can be difficult unless you have an established company with a good reputation. If you can convince the other party to the contract that your company is financially healthy, then the other party might agree to remove the personal guarantee. Financial statements for the last few years can help prove your company is healthy. Another option is to ask for the guarantee to expire after the first year or two of the contract.
6. How Do You Get Out Of A Personal Guarantee After Signing It?
This can also be difficult. Parties to a contract want as much security as possible to make them whole in the event the other party breaches the contract. If a party to a contract has the option to collect from a company and one or two or three individual personal guarantors, for example, it is unlikely they will voluntarily give up that security. After a year or two of the company meeting its obligations under the contract, it is possible the other party would agree to release the guarantors from the personal guarantee.
To conclude, if you are asked to sign a contract with a personal guarantee, it is prudent to take the necessary time to analyze the risk. If you cannot personally afford to bail out your company in the event of a breach, then you probably should not undertake that risk.