Oct 2, 201812:47 PMExit Stage Right
with Martha Sullivan
Personal guarantees — When business is personal
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If your business has debt, it is very likely that you, as an owner, were asked to sign a personal guarantee for the debt. Personal guarantees are often required by banks and always required by the Small Business Administration for any of the loans written under their programs. Personal guarantees are an effective tool used by lenders to ensure that they have another route to recover their losses should the business be unable to repay the loan in accordance to the agreement.
Two weeks ago, at the bimonthly meeting of the Wisconsin Chapter of the Exit Planning Institute, I heard all sorts of bells going off in my head as I listened to David Sisson, John Wink, and Greg Monday from Reinhart Boerner Van Deuren law firm. Their message was this: In a default, courts look to the document language to determine what’s fair according to what was technically agreed to in the agreement. What’s technically correct may not be fair — or at least what you and I would consider fair.
Consider the following case: Two 50-50 owners take out a loan for the business and ultimately they can’t keep up with it. The bank calls the loan and personal guarantees. One of the owners has resources and the other doesn’t. Mr. Moneybags pays just shy of half of the amount of the original debt. Mr. Hole-in-the-Bucket pays 2 percent of the original amount because that’s all he has. Moneybags sues his partner to recover some portion of his payment from his partner. After all, they are 50-50 partners and he shouldn’t be left holding the bag. The court disagreed. The court viewed “fair” as half of the face amount of the debt to the bank according to the loan documents. The settlement agreement between Moneybags and the bank is independent from what the bank ultimately agreed to with the other party. He signed an agreement, was technically on the hook for the whole amount, and paid only half of the debt amount. From the court’s view, Mr. Moneybags only had to pay his fair share at half of the total amount. Absent any other agreement with Mr. Hole-in-the-Bucket, per the court, that’s the end of the story.
Holy Buckets! That’s not what most of us would say is “fair.” So, let’s break it down:
- Both parties signed a personal guarantee for the debt.
- The guarantee was “joint and several” meaning each party, independent of the other, can be held responsible for the entire amount of the debt.
- The guarantee was unlimited. Again, each party can be on the hook for the whole amount.
- The matter involves an agreement between the bank, the company, and the individuals with the personal guarantees. The actual corporate ownership structure does not play a role in the legal interpretation and the courts in this matter.
- The bank was well within its rights to negotiate and recover what it could. As it was, the bank ate over 30-40 percent of the original amount it loaned to the company. The fact that they only held Mr. Moneybags to half was generous compared to what the letter of the agreement allowed for.
Considering this scenario and court precedence, what can an individual business owner do to protect him or herself in case things go south?
First, personal guarantees deserve deep discussions with your banker. Understand the obligation, what may or may not be negotiable, and what actions the bank can take. Go in with your eyes wide open.