Personal Guarantee - the Good, Bad and Ugly

What is it?

Who Wants It and Who Doesn't?

The GOOD . . .

If your business is extending credit to another corporation or LLC, you definitely want to get an undertaking from the owner. That way, if your borrower defaults, you can look to the personal assets of the guarantor to collect. In this case, the personal assurance is GOOD!

The BAD . . .

If your LLC or corporation is attempting to borrow or obtain credit from a bank or vendor, you may be asked to give a guarantee. If you do so, you have just lost the limited liability of your business entity as to that creditor. You're on the hook personally if your business doesn't pay. That's BAD! Usually, however, your limited liability will be preserved as to other potential claimants who don't have a guaranty.

In some cases your guarantee may benefit more than one creditor. For example, when a corporation or LLC applies for a Nevada contractor's license, the Contractor's Board may require a personal guarantee from the owner as a condition to issuing the contractor's license. By giving that guarantee, if his business doesn't pay its business debts incurred in the course of the contracting business, the owner may be personally liable to vendors, suppliers, other contractors, laborers, and homeowners who have a claim against the business.

The UGLY!

A personal guaranty usually remains in place until it is canceled in writing. That can be a trap to the unwary or the uninformed because the guaranty may extend beyond when the guarantor has anything to do with the business.

A new client recently came to our office because he had received a number of demands from creditors under several different personal guarantees which he had signed years ago. Two years ago he had sold his interest in the business and had nothing more to do with it. But he didn't go to the lenders and the vendors to cancel his guarantee in writing. Recently his former business quit paying its bills, and our new client was faced with having to pay on his personal guarantee. That's UGLY!

This unfortunate client does have the right to sue his former business and the new owners for subrogation to recover what he has to pay out, but that's not much consolation. He still has the time and expense of litigation and the hassles of trying to collect the judgment once he gets it.

The continuing nature of personal guarantees can be a ticking time bomb. You tend to forget about them until they explode!

So what's the lesson to be learned?

If you're the business which is extending credit to an LLC or corporation, you definitely want to get a personal undertaking. You want the assurance of getting paid because the owner is on the hook personally.

If you're the business which is asking to get a line of credit, you want to avoid it if at all possible. If asked, just tell the vendor that your policy is not to give personal guarantees. What the heck! It never hurts to ask!

If you have to give an undertaking, don't forget that it's out there. When your business gets big enough to have its own critical mass and a good financial statement, then you can go back and ask to cancel your guarantee.

Above all, be sure to send written cancellations for all of your personal guarantees if you leave or sell the business. The cancellation may not be good for existing obligations, but you can certainly keep it from applying to new obligations.

Our firm is knowledgeable about all aspects of contract law, including guarantees, and we would be pleased to assist you in this area. For a no-charge 1/2 hour consultation with Dave Guinan, click here.

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