In today’s Freedom Friday blog and email newsletter, I want to talk about another topic that I’ve discussed before, but I still don’t get a lot of questions or concerns from a small business owner until it’s too late, and that’s personal guarantees. Many small business contracts include a personal guarantee that must be executed by the owner of the business. This means the owner agrees to be personally responsible for the debt or obligation if the business cannot pay or fails. Even when a company is structured as an LLC or corporation, a personal guarantee allows the lender or vendor to pursue legal action against guarantor and not just the company. In today’s Freedom Friday blog and email newsletter, I’m talking about how to understand personal guarantees in small business contracts.
A personal guarantee is a clause in a contract which requires an individual (the guarantor) to repay a business obligation if the company fails to do so. As a result, it bypasses the limited liability protection that usually shields owners of LLCs or corporations. Personal guarantees are common in many business contracts including commercial leases, bank loans, equipment financing agreements, vendor supply contracts, and commercial credit applications. Landlords and lenders often require a personal guarantee when dealing with newer businesses, companies with limed credit history, or businesses with fewer assets. The personal guarantee helps assure the other party that the obligation will be paid. If the company defaults, the creditor can pursue legal action against both the company and the individual who made the guarantee.
Personal guarantees reduce the financial risk for the party providing credit, financing, or property. Many small businesses operate through LLCs or corporations which limit the liability of business owners. A personal guarantee gives creditors another path to pursue repayment if the business fails or cannot meet its obligations. Common reasons that creditors require personal guarantees include the business is newly formed with limited financial history, the company or business has minimal assets to secure the obligation, the transaction involves significant financial exposure, and the creditor needs or desires an additional repayment source. For instance, a commercial landlord may require the owner of a startup to personally guarantee the lease because if the business closes before the end of the lease term, the landlord is able to pursue unpaid rent from the guarantor.
Not all personal guarantees carry the same level of risk. The specific language in the contract determines the scope of liability. Two common forms of guarantees include an unlimited personal guarantee which makes the guarantor responsible for the full amount of the debt or the obligation, including interest, fees, and collection costs; and limited personal guarantees which restrict the guarantor’s liability to a specific dollar amount or a defined percentage of the obligation. Some contracts also include joint and several guarantees, which means multiple owners each become individually responsible for the entire obligation. A creditor may pursue one guarantor for the full balance even if others signed the agreement. Because the terms vary widely, you need to review the contract language carefully to understand the level of personal risk involved.
If a business or company fails to meet its obligations, the creditor can enforce the personal guarantee against the guarantor. Typical enforcement steps include declaring the loan or contract in default, demanding payment from the guarantor(s), filing a lawsuit against both the company and the guarantor(s), obtaining a judgment, and pursuing post-judgment collection remedies through liens and garnishments. In many instances, creditors first attempt to collect from the business itself, but the guarantee often allows them to pursue the guarantor, as well, without exhausting all remedies against the defaulting company. Thus, the financial impact can be significant because the guarantor’s personal assets are at risk because they are exposed to collection.
Thinking about starting a small business? Or maybe your small business is having issues with contracts, leases, business partners, collection issues, or experiencing other barriers to growth? Please contact me at Jonathan@libertylegalok.com to schedule a FREE strategy session.
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