What is a Personal Guaranty?
Have you ever…
Entered into a lease agreement with a landlord?
Financed a vehicle?
Taken out student loans?
If you answered “yes” to any of the foregoing questions, you have also likely signed a personal guaranty. A personal guaranty is, simply put, a promise made to repay a debt. When you sign a personal guaranty in your individual capacity, you personally agree to be held responsible for the repayment of the indebtedness. You also are known as the “guarantor.” Perhaps you are a parent who has co-signed the car loan or the student loans - in that case, you are the “third-party guarantor,” indicating that while you are not personally receiving the benefit of the financial arrangement, you are promising to repay the debt in the even that the guarantor defaults or becomes insolvent.
A personal guaranty must be set forth in writing, and it must also be clear from the personal guaranty that you are signing the guaranty in your personal capacity.
Business owners can be subject to a personal guaranty, as Laura and I (Amy) have worked with clients whose businesses have become insolvent, thereby leaving them, as the business owners, to be personally responsible for the business debts. Let’s look at an example of how a personal guaranty works for a business owner.
Imagine, for a moment, that you are a personal trainer and are looking to open a training facility. You have duly and properly incorporated your training business as “Strong Work, LLC.” You have found a space in a commercial building that is zoned for fitness/gym facilities that is perfect for your clientele base and in a desirable location. Your facility will be called, “Strong Work.” The landlord has offered you a lease for a three-year term, with a security deposit due upon execution of the lease and monthly rent payments of $1,000.00 due by the 1st of each month. The landlord will also require you - as the owner - to execute a personal guaranty set forth in the lease agreement. By this personal guaranty, you are agreeing to be held personally responsible for the performance of Strong Work, LLC under the terms of the lease, including timely monthly rent payments. Therefore, in the event that the LLC becomes insolvent at some later date, you, as the guarantor, are required to pay the monthly rent notwithstanding the entity’s solvency or insolvency.
Let’s further imagine that you are looking to equip this new training facility with the latest and greatest training equipment. You know that it will costs a bit of money to get the equipment, but having crunched the numbers with your finance and accounting professionals, you expect that the equipment will pay for itself in a short period of time. Therefore, you approach Big Bank to obtain a business loan so that you can purchase the gym equipment. After a rigorous review process, Big Bank agrees to extending the necessary financing to you so that you can purchase the equipment you need. Big Bank is going to require you to sign a personal guaranty, thereby promising to repay the loan in the event that your projected revenue from training sessions is not realized. If Strong Work, LLC does not capture the necessary revenue to continue to make payments under the Big Bank loan, Big Bank can seek to satisfy the loan balance (i) by acquiring the LLC’s assets (i.e., the training equipment) equal in value to the loan balance and/or (ii) by personally suing you as the guarantor of the loan.
A common question is whether or not a personal guaranty can be revoked at any point in time. The answer is yes. A personal guaranty can be revoked if the financier/lender/lessor agrees to the revocation in writing. Let’s take our hypothetical one step further. You have been training a client, Jane Smith, for more than a year. At this point, your training equipment is fully paid off, and the only personal guaranty to which you are subject is set forth in the lease agreement, for which there remains 2 years on the initial term. She has obtained her personal training certificates and has garnered attention from her friends and family by her own success in her fitness journey. Jane approaches you and asks if you would be interested in partnership with her. Instead, you find this to be an excellent time to depart from the training circuit and focus on another endeavor. After long negotiations with your attorney, Jane, and her attorney, the end product is that you will sell Strong Work, LLC, its customer lists, its equipment, etc. to Jane outright. She agrees. You then approach the landlord, Bob Doe, and advise Bob that Strong Work, LLC will be undergoing a change in ownership interest. You have advised Bob that you would like to revoke your personal guaranty under the lease and that Jane Smith will be assume the lease and the personally guaranty. Bob agrees, thereby releasing you from the personal guaranty under the lease and requiring Jane Smith to personally guarantee the terms of the lease as the new owner of Strong Work, LLC. This revocation is reduced to writing, duly executed and exchanged by all parties.
While many people will experience a personal guaranty in their personal lives - when leasing an apartment or home, financing a new car, or taking out student loans - it is crucial for a business owner to understand the gravity and consequences of his or her personal guaranty of the business’s obligations. Before entering into any agreement that requires a personal guaranty, we strongly suggest that you ask trusted counsel to review the document with you fully so that you understand how the guaranty affects you and what your obligations thereunder will be.
Disclaimer: The information contained in this post is not, nor is it intended to be, legal advice. You should consult an attorney for advice regarding your individual situation. We invite you to contact us and welcome your calls and communications. Contacting us, however, does not create an attorney-client relationship.