Personal guarantees of business debt – think before you sign!

As a condition of making a loan to a borrower with few assets and no credit history, a bank will often ask other more solvent individuals to sign a document called a “personal guarantee” or to “co-sign” on the debt. The most common example is when the members of a start-up limited liability company are asked to guarantee the debt of the LLC as a condition of the business getting the loan. Sometimes a parent will be asked to co-sign on a home or car loan for a child. (Co-signing simply means that you are a primary borrower on the loan versus guaranteeing repayment of a loan on which another person or entity is the borrower.) No matter the form, always treat your decision to assume responsibility for someone else’s debt as a very important business decision that can have disastrous economic consequences if the debt is not repaid.

As a practical matter, there isn’t much difference between co-signing on the debt as a borrower or signing a personal guarantee. We will focus our discussion on guarantors because that his the more common arrangement. While the documents you are asked to sign will control your obligations, those documents almost always create unconditional joint and several liability for all guarantors. What that means is that each guarantor is responsible for the entire debt and that there is no requirement that the bank pursue the borrower before it pursues the guarantors.

To illustrate, assume that a LLC borrows $100,000.00 to buy a piece of real estate. John Doe and Jane Doe are members of the LLC and sign guarantees of the loan. The LLC is unable to sell the real estate and cannot repay the debt by the deadline. If no resolution is reached, the bank will send letters to the LLC, John, and Jane demanding payment of the debt, in full, within 10 days. The bank will not ask for John to pay 1/2 and Jane to pay 1/2. If the loan is not paid off and a suit is filed, the bank will ask the court for a judgment against John and Jane both in the amount of $100,000.00, plus past due interest, late fees, and attorneys fees of 15% of the total principal amount due. While the bank can only recover what it is owed once, John and Jane will both be responsible for the entire amount. What’s worse, the bank often will not foreclose on the real estate first. It is not required to do so and it has an incentive under Georgia law not to do so. The bank can thus pursue recovery of the full amount of $100,000.00 from both John and Jane by, e.g., garnishing their bank accounts and wages and foreclosing against other free and clear assets they may own, until the full amount of the debt is satisfied. If, for example, John had $120,000.00 sitting in a savings account in his name, the bank could recover all of that money then release its security interest against the real estate that was supposed to be collateral for the loan. If they have no assets, John and Jane may be faced with personal bankruptcy when they are sued by the bank while the real estate they thought secured the loan sits unsold and useless.

At Orr & Brown LLP, we have handled tens of millions of dollars worth of loan default cases. Most of the cases we handle involve larger business loans of high six, seven, and eight figure amounts. No matter the size of the loan, these cases can have complex and unique defenses revolving around, e.g.,  the timing of the guarantees, the history of the loan, and even the marital status of the borrowers! You can see a sample of the results that we’ve obtained for our clients in these cases here. Very often, expensive and time consuming lawsuits can be avoided if problem debts are not ignored by the guarantors; guarantors who tackle these problems head on typically get better outcomes. The best advice is to consult with an experienced attorney before you take responsibility for someone else’s debt and sign a guarantee. Know what the capacity of your fellow guarantors is going to be to help shoulder the repayment burden if the loan goes into default. If a loan that you have guaranteed is headed for default, contact a qualified attorney early and get advice as to your legal rights and obligations. If you receive a dreaded ten-day notice, know that litigation is likely soon to follow and hire a qualified attorney to defend you.

For all of these reasons, guaranteeing a loan or co-signing on a debt is a major business decision. Educate yourself as to the risk you are taking before you sign and know what is going to happen of the loan does not get repaid.

 

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