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One of the dreaded documents any business owner faces in a deal is the “personal guaranty.” After all, the business owner went through the steps to incorporate or organize their business just to avoid this personal liability, and now a lender, landlord, supplier or service provider is demanding the owner sign a personal guaranty. While it’s understandable from the other side’s perspective, it’s one of the greatest sources of personal risk to a business owner.

Of course, the owner can simply refuse to sign the guaranty, but that may simply kill the deal. If the other party won’t take a simple “no” for an answer, most owners will do a cursory read of the guaranty (it is, after all, usually 1-2 pages, so it must be standardized, right?), sigh, and sign on the dotted line. And if things do go south, an owner who signed the guaranty may think the guaranty automatically obligates them for any debt owed by their company to the beneficiary under the guaranty. But as with all legal issues, the devil is in the details, and there are things that business owners can do to protect themselves with respect to a personal guaranty, both proactively during negotiation as well as possible defenses after the fact.

1. What Does the Guaranty Actually Say?

This may seem to be an obvious point, but it is one that is often overlooked. The guaranty is a separate contract from the underlying obligation, and so the first and best defense of a guarantor is to examine the language of the guaranty for its terms. Guaranties are not one-size-fits-all; the terms vary from guaranty to guaranty, and if the guarantor is still in the stage of negotiating the guaranty, many essential terms of the guaranty may be negotiable.

Length of the Guaranty: Although most creditors would prefer for a guaranty to cover the entire term of the underlying obligation, some guarantors have had success negotiating a more limited term. A start-up business, for example, may be able to negotiate a guaranty limited to the first two or three years of a five- or ten-year lease on the rationale that if the business makes it the first couple of years, it is likely to survive the remainder of the term.

What Debts are Guarantied? This is a key provision. Most initial drafts of personal guaranties provide that the guarantor is to guaranty all future debts to the creditor, including all “extensions, modifications, amendments, and renewals” of those debts and obligations and their underlying agreements. If there are multiple guarantors, the creditor will most likely insist that each guarantor guaranty the entire amount of the debt, that is, joint and several liability among the guarantors. Depending on their bargaining power and the financial solvency of the individuals involved, the owners may be able to negotiate more limited terms. If an owner guaranties a service agreement, it may make sense to have the personal guaranty limited to just that one agreement and not to any extensions, modifications, renewals or other service contracts between the parties.

Amount of Guaranty: If there are multiple guarantors, each guarantor may negotiate to have his or her personal guaranty limited to a pro-rata fraction or an absolute dollar amount of the overall obligation. We have negotiated guaranties where each guarantor, an owner in the enterprise, has agreed to guaranty a fraction of the debt and not the entire amount. Such an arrangement works best if there are more than two guarantors, each of whom has financial resources that, at least on their face, are sufficient to readily satisfy the obligations.

Right to Terminate Guaranty:Another provision to consider is the inclusion of a provision that permits a guarantor to terminate the guaranty. Termination in this instance does not dispose of the guaranty, but rather, limits the amount to be guarantied to that amount outstanding as of a date certain, plus any orders in process. Such a provision provides one of multiple guarantors the right to limit liability, which becomes extremely important when an owner/guarantor leaves a business, whether voluntarily or involuntarily. A correlative right in such situation is for the beneficiary under the guaranty to either call on the guaranties or demand additional collateral.

Who Executes the Guaranty? Missouri is one of a handful of states that recognizes a tenancy by the entirety in property ownership. Tenancy by the entirety is a type of joint ownership between married couples, and it is the most common form of home and other asset ownership between spouses. One of the biggest benefits of tenancy by the entireties is that the creditors of one spouse cannot execute on property owned in this form to satisfy a debt, including a judgment. Thus, if an owner can negotiate to sign a personal guaranty by him or herself, but without his or her spouse’s signature, then their home and other assets may be shielded from execution in the event of a default.

2. What if Collateral is Wasted?

What happens if, after a default, a creditor forecloses on collateral, sells it and comes after the guarantor for a deficiency? Most personal guaranties will contain language waiving the guarantor’s rights against the creditor for waste of collateral, including failure to sell the collateral for full market value. Nonetheless, the language of the guaranty may not be the last word on the issue. Courts in Missouri have held that the creditor has a duty to act in good faith and with reasonable care with respect to collateral, regardless of the terms of the guaranty. If the creditor fails to do so, the guarantor may be partially or completely relieved of liability.

3. What if the Personal Guaranty is Defective?

Although lenders will usually (but not always) have well-prepared forms, many other businesses use stock forms or borrow forms from the Internet for their personal guaranties. The end result may be misused terminology, bad references, omissions of essential terms, or other problems that may reduce or eliminate the effectiveness of the guaranty. Courts construe personal guaranties strictly—that means that any defect in the personal guaranty is likely to benefit the guarantor, and may render the guaranty partially or completely void.

4. Is the Guaranty of Payment or Collection?

The phrase, “this is a guaranty of payment and not of collection” or similar terms are common language in guaranties. In short, some guaranties, such as guaranties of payment, are “absolute” guaranties—the creditor can immediately proceed against the guarantor in the event of a default on the obligation. In conditional guaranties, the creditor must first undertake to collect the debt from the debtor, including litigation, before the guarantor becomes liable for the obligation. If the creditor fails to follow the proper procedure, the guarantor has no liability for the debt.

5. Are There Material Changes to the Underlying Obligation?

In general, a guarantor must agree to any material changes in the underlying obligation. Extensions of credit to the principal, changes in terms of repayment, or other modifications that alter the obligations to the detriment of the guarantor may partially or completely release the guarantor from his or her obligation. Most guaranties proactively contain these consents to modification (see above), but these are terms that may be negotiated at the beginning of the relationship.

Since the personal guaranty is one of the principal (and often unavoidable) personal risks of a business owner, it is essential that the would-be guarantor understand the terms and risks of the guaranty and, perhaps more essentially, see where negotiations can avoid some of the harsher provisions of a guaranty.