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Business · August 29, 2022 · by Roy Banerjee

What You Need to Know About Personal Guarantee

› Business › What You Need to Know About Personal Guarantee

client signing a document in an office with a businesswoman looking at contractOfficers and owners within a company have a wide array of responsibilities, many of which involve the finances of the business. While they typically have a fiduciary duty, or a responsibility to act within the best interests of the business rather than only for themselves, this does not preclude them from involving themselves personally in the company’s finances.

One such acceptable method of doing so is by providing a personal guarantee during a transaction or engagement with another party. However, personal guarantees also carry significant risks, and the decision to use them should not be made lightly.

What is a Personal Guarantee

A personal guarantee is one means of facilitating a financial transaction in a legally binding manner. Such a guarantee is not merely a verbal promise of goodwill.

Most commonly, a personal guarantee serves as an individual promise made alongside the business to pursue credit, especially if the interested party does not have the standard qualifications to apply. The individual agrees to be responsible for the financial repercussions of the agreement if the business is unable to pay or otherwise uphold its agreed-upon responsibilities.

In this way, the individual who made the guarantee becomes personally responsible for the business’ debt. In normal business practices, the structure of the company may protect its owner or partners from financial liability if the business defaults on loans or suffers other financial repercussions, but a personal guarantee binds the relevant individual into the debt owed, and the business’ failure to pay could result in the guarantor’s own assets being seized.

Most Common Uses of a Personal Guarantee

man signing loan agreementPersonal guarantees can be a powerful tool to enable a business to achieve financial success in ways that it may not have access to on its own. For this reason, small businesses without significant assets or a long financial history are the most frequent users of personal guarantees.

Small businesses may not have sufficient credit history as their own entities, either because they are recent creations or because they have not utilized credit in their past. Similarly, businesses with poor credit history, missed payments or defaults in the past could struggle to secure financing in the future, leading to the need for a personal guarantee.

Otherwise, businesses can become trapped in a repetitive cycle in which their credit is not good enough to achieve financing, but they need financing in order to improve their credit.

In this scenario, the business owner may use their own credit history to cover the gap that their business is lacking. Normally, business and personal financial dealings are considered separate, and a business owner or partner’s own credit score and money history are not factored into the opportunities that the company receives.

However, a personal guarantee can be utilized to essentially use the credit of the individual, not the business, if that is more favorable. Thus, a business that does not have a high enough credit score to qualify for a business line of credit, for example, can rely on the higher credit score of its owner.

In exchange, the owner is responsible for the line of credit, and if the business is unable to pay off the account, the lender may pursue action against the business owner who offered the guarantee in order to seize assets commensurate with the amount owed. In addition to the greater opportunity due to a personal guarantee, comes additional responsibility and potential risk.

The specific terms of a personal guarantee are flexible, and owners may offer not only their cash and bank account contents to back their claim but also assets such as vehicles or real estate. This can make an individual with a personal guarantee a more favorable choice for a lender, leading to better interest rates and terms for loans.

However, a business unable to secure financing is not the only type for whom personal guarantees are helpful. Businesses may use a guarantee to secure more favorable terms, such as lower interest rates or a smaller upfront payment, depending on what type of financial move they are trying to execute.

Lenders view any engagement backed by a personal guarantee as lower risk, because they have multiple entities from which to attempt to recover their investment if the debt is not paid. However, this also grants them access to an individual’s accounts, assets and even real estate, which means that the individual making the personal guarantee should carefully consider the risks involved.

Businesses can build credit history using guarantees, but unexpected fiscal developments can have long-term effects on the guarantor’s financial wellness.

Examining the Terms of a Loan

loan terms and conditions under magnify glassEven those who are financially savvy may not realize that they have already been subject to personal guarantees in the dealings they have already had. In fact, some loans may write a personal guarantee into the terms and conditions, which is why it is important to always read these details.

You may already be bound by a personal guarantee, even if you did not intentionally agree to this practice, when you signed a contract. A legal professional can help you to understand if you are liable as a payer for a guarantee, but in general, you must pay attention to the language of the contracts you sign.

The terms and conditions that bind you as a personal payer for a business may appear directly under the verbiage of “personal guarantee”, or they may appear when describing you as being “jointly and severally liable with the company.” In both of these scenarios, you are agreeing to a personal guarantee, and your own finances can be seized if the business fails to pay its debts.

Limited vs. Unlimited Guarantees

Once you have agreed to a personal guarantee, it becomes legally enforceable. However, the type of guarantee that you make can vary, and each variety has its own terms and conditions which impact the financial repercussions of your decisions.

Guarantees are not set in stone by a government entity so you may be able to negotiate the terms to some extent with all involved parties. In general, the two types of personal guarantees available to you are limited and unlimited.

Limited guarantees restrict the lender to collect only a limited amount of money owed. For example, a limited guarantee on a transaction of one million dollars may mean that, if the business does not pay anything and defaults on its debt, the lender is restricted to collecting only $250,000, even though it is still owed the original one million. How limited guarantees are calculated comes down to the initial agreement, which is why you should be vigilant during the establishment of terms.

limited guarantee form in clipboardA limited guarantee may be based on a percentage of the overall balance; in the example above, the lender may have been restricted to collecting only 25% of what was owed, with no option to collect more based on the terms of the agreement.

Limited guarantees may also be established as a percentage split between multiple partners, e.g., four partners are all personally liable, so each is responsible for 25% of the debt. Structuring a limited guarantee may be based on the type of business you own, whether you have partners, how large the debt is and other criteria.

Conversely, unlimited guarantees mandate that the principal (that is, the person who made the guarantee) is responsible for the entire amount. The Small Business Administration only issues loans with unlimited personal guarantees, which means that if the business cannot pay off the loan or meet its debt obligations, the person who made the guarantee becomes responsible for the entire amount.

Insufficient liquid assets do not matter; if there are not enough liquid assets to pay off the balance, real estate and other assets can be used to recoup the cost. Making a personal guarantee with an unlimited condition can pose a significant risk to an individual’s own financial wellbeing and long-term success.

In addition to your home, vehicle or other assets being seized to pay what is owed, any future wages may also be garnished to claim a portion of your income toward the debt.

Trust the Professionals to Help You Understand Your Responsibilities

making agreements with customers to buy houses and land and sign contract documentsPersonal guarantees can be a powerful financial vehicle to achieve your goals for your business, but they come with significant risks. In addition, some of the contracts that you sign as part of your business operation may have language suggesting personal liability; it is important that you understand what you are agreeing to and whether it is enforceable.

Similarly, if you are the party writing the contract, it is important that you properly word clauses relating to personal liability, or you may be faced with an attempt to recoup debt that is not legally valid.

Whether you are deciding to seek credit by leveraging a personal guarantee or you need assistance drafting a contract that includes such details, be sure to work with legal experts. The professionals at KPPB LAW will gladly help you understand the roles and responsibilities that come with making or requiring personal guarantees so that you can make informed decisions. Contact KPPB LAW to learn more about the variety of services that we offer, or to schedule a consultation to discuss any questions that you may have.

If you are considering litigation related to a contract dispute, consider the value range of your matter with the investment of engaging an attorney to be sure your legal action makes fiscal and business sense.

Filed Under: Business

Roy Banerjee profile picture
Roy Banerjee

Roy Banerjee helps defend, settle and pursue claims to protect your business interests. He is an accomplished business litigator who specializes in efficient resolution of real estate and business matters.

Legal Disclaimer*

Articles published by KPPB LAW are purely for educational purposes and provide generalized information of the topic(s) covered. These articles should not be considered as legal advice.

Please contact the attorneys at KPPB LAW for more information regarding your case.

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