Personal Guarantees: Financial Land Mines
In a typical commercial loan situation, the borrower is a LLC or other business entity with few assets or track record. The lender wants the members of the LLC (the partners in the busienss) to be personally responsible for repaying the loan if the business does not. Sometimes, in the personal loan context, the borrower doesn't have enough personal credit history to justify the loan, so the bank will ask a parent or other more solvent party to guarantee or "cosign" the debt. No matter the circumstances, signing a guaranty of someone else's debt is a serious matter that can have disastrous consequences for the guarantor. Signing these documents as a favor to a child or loved one or with a "what the heck" attitude in a business setting is dangerous, and this article explains why.
Guaranty agreements almost always create unconditional joint and several liability for all guarantors. That means that each person who signs a guaranty is individually responsible for repaying the entire debt. It's a common misconception that the bank is required to pursue the other guarantors, the borrower, or to sell the collateral before seeking the full amount of the debt from the guarantor. Although the borrower and guarantors often think that they are in it together, that's typically not the case.
A hypothetical example will illustrate the point. Assume Newco LLC borrows $500,000.00 to buy a small office building. John Doe and Peter Doe are members of Newco, and the bank requires them to sign guarantees of the loan. The LLC is unable to fully lease the building, and it falls behind on the note payments. The loan goes into default. Here, if workout discussions fail, the bank's lawyer will typically send certified mail letters to the LLC, John, and Peter demanding payment of the full debt within 10 days. Although John and Peter may be "in it together," the bank will be asking both of them to pay the entire $500,000. The bank is not required to foreclose against the office building first under Georgia law, and may choose not to do so while they sue John and Peter. (The bank has an incentive under Georgia law not to foreclose first, which will be addressed in a separate article.)
If John and Peter don't pay the debt in 10 days, the bank will file a lawsuit against them and ask for a judgment for $500,000 against both of them. The bank will then be able to garnish John's and Peter's bank accounts and levy on other personal assets (cars, boats, or airplanes) until the entire $500,000 is repaid, plus penalties, interest, and attorneys' fees. John and Peter may be forced to file bankruptcy while the building they thought secured the loan sits unrented and untouched. The bank can collect the judgment--and enforce its guaranty agreements--against both John and Peter or either of them. For example, if Peter has the full $500,000, but John has zero (or has filed bankruptcy), then the bank can collect the full $500,000 from Peter. It does not have to collect half from one guarantor and half from the other guarantor.
You should consult with an experienced attorney before you sign a personal guaranty, whether of corporate debt or otherwise. It's fair to ask about the financial capacity of the other guarantors to know whether they can help bear the burden if the loan goes into default. And if you have already guaranteed debt, then don't ignore a problem loan that you have guaranteed. If a default appears imminent, contact a qualified attorney before that happens and get advice about your legal rights and obligations. You have nothing to gain by delay and much to lose.
If you need counseling regarding a personal guarantee of corporate debt, either before you sign it or if the loan goes into default, contact the attorneys at Johnson Marlowe LLP.