If you own or are acquiring a small or medium sized business, you probably have been faced with a request from a bank or other creditor to sign a personal guaranty for credit extended to your business. Many business people do not realize that they do not necessarily have to sign a personal guaranty in the form first presented by the bank or creditor; there is often room for negotiation and flexibility when it comes to entering into these arrangements.
Before we talk about the negotiable aspects of a personal guaranty, let’s first clarify what a personal guaranty is. In most cases, a personal guaranty is not really a guaranty at all, but is referred to more properly as a suretyship. A suretyship is an undertaking by an individual or entity to be primarily and equally responsible for credit extended to another person or entity. Notice we use the word primarily. Most suretyships provide that the bank or creditor can collect from the surety first, without necessarily having to go against the underlying borrower. Lenders have created confusion, however, because they still continue to call these documents “guarantys” rather than suretyships. By way of contrast, a guaranty is classically understood to involve a relationship whereby the guarantor agrees to be responsible for a debt of the borrower if the lender or creditor cannot first collect from the borrower. A guaranty was generally considered secondary to the underlying debt, not primary or co-equal. It suffices to say that most lenders will ask you to sign what amounts to a suretyship even if they continue to call the document a personal guaranty.
As a business person, what can you do to protect yourself when asked to sign a guaranty or suretyship? These documents are often weighted heavily in favor of the lender with draconian remedial provisions and severe penalties for nonperformance. In a nutshell, given the financial exposure presented by these documents, we cannot recommend strongly enough having them reviewed before you sign by a trusted legal advisor. He or she will scrutinize the document with an eye toward accomplishing some or all of the following modifications:
- The best approach is to try to avoid signing the personal guaranty in the first instance; this negotiation usually involves convincing the creditor of the creditworthiness of the underlying business borrower and the availability of sufficient assets and income to secure the debt.
- If the document is entitled “guaranty”, try to have it modified so that it is truly a guaranty, i.e. with the creditor required to proceed in good faith first against the business borrower and its assets before looking to guarantors for payment.
- Along the lines of the foregoing comment, effort should be made to limit the guaranty to a specified “cap” amount which is lower than the total of the credit extended to the business; also, an effort should be made to guaranty only the last portion of the unpaid debt and not the first dollars that are due from the business borrower.
- An attempt should be made to modify or eliminate confession of judgment and similar harsh remedies from the guaranty.
- Spouses should never be required by the lender to sign the personal guaranty and every effort should be made by the business borrower to avoid offering the guaranty of a spouse. As we have observed in prior editions of the Law-Update, a creditor who requires a spouse to sign a personal guaranty may be in violation of the Equal Credit Opportunity Act, a serious offense which could render the guaranty unenforceable or give rise to a claim for damages.