Promises, Promises – Navigating the World of Personal Guarantees
November 10, 2008
Due to the difficult financial situation of many companies and their customers, depending upon which side of the issue you are on, it is more important than ever to attempt to minimize or maximize the amount of corporate debt that is personally guaranteed when obtaining credit. Should a company dissolve or become defunct, a creditor’s only recourse maybe via a personal guarantee.
A personal guarantee is a promise by a person, (Guarantor,) usually a shareholder, to become personally liable for the debt of a corporation. If the corporation cannot pay its debts, and its assets are not worth enough to cover the debt, the Guarantor risks his personal assets being attached and seized by the creditor of the corporation. This exposure can also occur when a company refuses to pay its debt. Once the corporation defaults on its obligation to a creditor, the creditor may choose to enforce the guarantee, rather than filing a lawsuit for payment.
Although shareholders are the owners of the corporation, the corporation itself is recognized as an independent entity under most laws. As such, although a person may be a majority shareholder or a sole shareholder, the corporate structure does provide a level of liability protection. Typically, the corporation enters into all legally binding contracts and agreements, whether it is for purchasing goods and services or financing arrangements. In the event that one of these contracts should be breached, the liability belongs to the corporation. However, if the shareholder executes a personal guarantee, he will be jointly and severally liable for the corporation’s obligation.
As a general rule, creditors cannot seize a shareholder’s personal assets to pay business debts unless that shareholder specifically gives up his protection. Unfortunately, most small business owners are forced to give up their right to limit their personal liability when entering into credit facilities. Many creditors require personal guarantees from the shareholders of a corporation before they will loan money or extend credit to the corporation. In addition, it is becoming more common place for landlords to require a personal guarantee before they lease commercial property to a corporation.
It wasn’t too long ago that the corporate form was reserved for the General Electrics and Ford Motor Companies of the world. Today, however, businesses that were formerly run as sole proprietorships are taking advantage of corporate entity advantages. The vast majority of the readers of this article are either closely held corporations themselves, or deal with closely held corporations every day. As such, if you have not had to navigate the world of personal guarantees, it is likely “guaranteed” that you will in the future.
The shareholders of most corporations are required to execute personal guarantees when they seek to obtain financing from a lending institution. From the perspective of the borrower, …
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by: Adam J. Basch, Esq.
November 10, 2008