What Is a Personal Guarantee?
A personal guarantee is when one person agrees to pay the debts or obligations of another person or a company. It is a legally binding personal promise to step into the shoes of the original party to the contract. For example, an individual may personally agree to pay off the debts of a company they are acquiring as part of the acquisition. A personal guarantee lawyer fulfills an important role, making sure that the person guaranteeing repayment fully understands the consequences of the agreement.
Why Might a Person or Entity Require a Personal Guarantee?
When a person is seeking a business loan, banks often will require a personal guarantee because businesses often do not have significant assets. For example, imagine that a person incorporates their landscaping business for tax purposes, and then they need to take out a loan to acquire transport vehicles and riding mowers to grow their business. The bank may be hesitant to lend money because the landscape company does not have any assets (such as real estate) to secure the loan. This is where a personal guarantee comes into play. If the business owner has assets (such as a home), then the bank may require them to put up their personal property as collateral for the business loan. The personal guarantee protects the bank in the event that the business is unable to repay the loan.
It is a slightly more complex situation when a business has multiple owners. In such a case, some banks may request a personal guarantee from each owner. At times, a bank might even ask a business owner’s spouse to co-sign on a personal guarantee.
If you personally guarantee a debt and do not fully understand all the terms and implications of the agreement, you could be setting yourself up for personal bankruptcy when the loan becomes due.
What Kinds of Problems Can Arise if I Sign a Personal Guarantee?
One common issue with personal guarantees is that the duration of personal liability can last much longer than a business owner anticipates. For instance, in businesses with multiple owners, an owner may still be held liable for loan guarantees even after they leave the business. Additionally, even if the business venture ultimately fails, a guarantor may still be responsible for satisfying the debt out of his or her personal assets. If the guarantor cannot satisfy the debt, this may result in a collection action being filed against guarantor – and may result in a loss of assets or, worse yet, a personal bankruptcy.
Another problematic scenario occurs where multiple owners take out a business and then one of the owners leaves the company. If the business then renegotiates the loan, the former owner may still be liable for personal guarantees even though they had no involvement in the renegotiation process.
In short, once a personal guarantee is signed and notarized, all signatories continue to be bound until the initial loan (plus any renewals and credit extensions) have been paid in full.
Common Types of Personal Guarantees
Some common agreements that require personal guarantees include:
- Lease agreements
- Rental agreements
- Small business mortgages
- Small business or corporate loans
- Unsecured lines of credit
- Vehicle loans