Obtaining financing is one of the biggest challenges facing business startups. Without another source of collateral, a bank might require a personal guaranty before it agrees to approve a loan to your business. While banks, financing companies, or other loan underwriters will always attempt to collect on a personal guaranty, there are circumstances where they are simply unenforceable.
What is a personal guaranty?
A guaranty is a promise to pay a debt. The guarantor is the person making the promise. The guarantor is often the person who needs the loan, but the guarantor can also be a third party that promises to make payment on behalf of another. A parent that agrees to co-sign on their child’s car or student loan would be an example of a third-party guarantor.
What liabilities are you agreeing to assume when you sign a personal guaranty?
When you sign a personal guaranty on behalf of a business, you agree to be personally responsible for repaying that debt in the event that the business later becomes insolvent. For example: your business manufactures and sells widgets, and it needs equipment in order to do so. You go to your bank and obtain financing for the equipment, and part of the financing agreement contains a personal guaranty. Later, due to an unexpected technological breakthrough, your customers suddenly no longer need widgets, and your business fails as a result. If the bank cannot recover the balance of its loan from the assets of your business, it will sue you personally for the remaining balance.
In other words, when you sign a personal guaranty in order for your business to receive a loan, you pledge your personal assets as collateral, including your home, the cash in your personal checking account, your savings and investments, and your future wages, which the bank can try to garnish.
Fortunately, you can get insurance to protect your personal assets in the event that you are the personal guarantor of a business that might one day no longer be able to pay its debts.
What factors make a personal guaranty unenforceable?
Personal guarantees are a critical aspect of many business contracts, so entrepreneurs and business owners should familiarize themselves with the potential consequences of signing one. Most importantly, to be enforceable, a personal guaranty must meet certain criteria.
A personal guaranty must be in writing and it must be signed by the guarantor in the guarantor’s personal capacity.
Though seemingly obvious, this important issue cannot be overlooked. To be enforceable as a personal guaranty, the signatory must sign the guaranty in his or her personal capacity and not as the “president” or “CEO” of the company receiving the loan, which is its own legal entity, separate and apart from the people that run and operate it.
A personal guaranty is not enforceable without consideration
In fact, no contract is enforceable without consideration. A personal guaranty is a type of contract. A contract is an enforceable promise. The enforceability of a contract comes from one party’s giving of “consideration” to the other party. Here, the bank gives a loan (the consideration) in exchange for the guarantor’s promise to repay it. In a lawsuit to collect a debt, the bank must prove that it has the right to collect the debt, i.e., that it gave the loan (i.e., the consideration) to the debtor. Sometimes, banks simply cannot produce documents showing a right to collect; this may be attributable, at least in part, to the number of times that loans are repackaged and resold. See, e.g., Stacy Cowley and Jessica Silver-Greenberg, As Paperwork Goes Missing, Private Student Loan Debts May Be Wiped Away, NEW YORK TIMES (Jul. 17, 2017).
Can a personal guaranty be revoked later?
An otherwise valid and enforceable personal guarantee can be revoked later in several different ways. A guaranty, much like any other contract, can be revoked later if both the guarantor and the lender agree in writing. Some debts owed by personal guarantors can also be discharged in bankruptcy.
Many factors can affect the enforceability of personal guarantees. If you have any questions about the enforceability of a personal guaranty that you have signed, or if you are considering signing one to get financing approved, please consult with one of our experienced Ohio business law attorneys who will assess your case and offer thoughtful legal guidance to support your decision.
Gertsburg Licata is a full-service, strategic growth advisory firm focusing on business transactions and litigation, M&A, and executive talent solutions for start-up and middle-market enterprises. It is also the home of CoverMySix®, a unique, anti-litigation audit developed specifically for growing and middle-market companies.
This article is for informational purposes only. It is merely intended to provide a very general overview of a certain area of the law. Nothing in this article is intended to create an attorney-client relationship or provide legal advice. You should not rely on anything in this article without first consulting with an attorney licensed to practice in your jurisdiction. If you have specific questions about your matter, please contact an attorney licensed to practice in your jurisdiction.