Seeking Bank Credit? Negotiate Your Personal Guarantees
submitted by Gregory F. Monday & Timothy S. Crisp
These days, if you are a business owner and your company is negotiating or renewing bank debt or lines of credit, you will be asked to give a personal guarantee. If you do not negotiate that guarantee, but rather accept the lender’s standard provisions, your guarantee will include features that could be quite onerous for you and your family and potentially devastating for your company. Therefore, before you provide a guarantee, work with the lender to make sure that your guarantee is only as broad as it needs to be and will not undermine the business upon your death or exit from the company.
A standard personal guarantee is a guarantee of payment, not collection, which means that if the loan is in default, the lender can pursue payment from the guarantor without first trying to collect from the borrower. Further, a standard personal guarantee is not limited in proportion or amount of the debt it guarantees. Finally, standard loan documents treat the death of the guarantor as an event of default — even though the guarantee survives as an obligation of the guarantor’s estate, often giving the lender the right to demand immediate payment of the loans and the guarantee and to foreclose on collateral.
Each of these features of a personal guarantee can be modified and should be negotiated to make the guarantee more appropriate to specific circumstances. Many lenders may be flexible regarding the terms of a personal guarantee, but they will not suggest such modifications unless they are asked. It is most effective to negotiate these changes as early as possible, preferably before the company signs a commitment letter. The following are some of the features you should consider negotiating:
- Collection or "Last-Out" Guarantee: The lender must exhaust its remedies against the company or its assets before it pursues payment from the guarantor.
- Guarantee Limited to Specific Obligations: The guarantee only covers specifically identified loans or credit lines, and not other obligations incurred with the lender.
- Guarantee Limited in Amount: The guarantee is only for a certain percentage or fixed amount of the debt. If you are not the only owner of the company, you can ask to limit your guarantee to an amount that is proportionate to your ownership interest.
- Reducing Guarantee: The amount of the guarantee reduces over time, so long as no event of default occurs.
- Guarantee Limited in Time: The guarantee lapses if no default occurs by a given date.
- Conditional or "Springing" Guarantee: The guarantee does not apply unless certain conditions are met, such the lender satisfying its loan covenants or extending additional credit, or the guarantee applies only after the occurrence of certain events, such as failure by the company to comply with loan covenants.
- Guarantee Limited to Specific Losses: The guarantee applies only if the lender’s loss arises out of specific circumstances, such as environmental contamination on pledged real estate.
- Fidelity, Validity or "Bad Boy" Guarantee: The guarantee applies only if the loan was obtained through fraud or misrepresentations, including borrowing base or other certifications.
Whether or not the lender is willing to negotiate the features of your personal guarantee, you should consider taking other defensive measures to mitigate the impact of the guarantee on your family and your business. For example, try to get the lender to agree that the death or disability of a guarantor will not be an event of default. The lender may agree if certain conditions are met, such as substitution of a suitable replacement guarantor, perhaps a successor owner, pledging of acceptable collateral or pay down of a specific amount, which could be funded with life insurance.
Also, make sure that you are indemnified by the company for losses arising out of the guarantee and that you will be released from the guarantee or at least indemnified by the continuing owners if you exit the business. Finally, ensure that your guarantee does not waive your right to seek reimbursement from the company and other guarantors.
The lender’s willingness to negotiate the guarantee will depend on a number of factors, including the creditworthiness of the company and any other guarantors, the value and quality of collateral securing the loans, the lender’s internal policies and risk tolerance, the pricing and amount of the loans, and current market conditions and trends. If a lender is unable or unwilling to modify the terms of a guarantee, you and the company should consider approaching other lenders to create competitive conditions.
If you are a married Wisconsin resident and your spouse will not be a guarantor, you should consider entering into a marital property agreement with your spouse. A properly prepared marital property agreement can reclassify property as "individual property" of your spouse, rather than "marital property" available to satisfy the lender’s claims under the guarantee. Make sure to provide the marital property agreement to the lender before you sign the guarantee.
By negotiating the terms of your personal guarantee and taking other defensive measures before you sign it, you can help prevent the guarantee from becoming a devastating liability for you, your family, and your business.
Attorneys Gregory F. Monday and Timothy S. Crisp are partners with Foley & Lardner LLP. Monday is vice chair of Foley’s Commercial Transactions & Business Counseling practice group and an adjunct professor at the University of Wisconsin Law School. Crisp is a member of the firm’s Finance & Financial Institutions, Consumer Financial Services, Health Care Finance & Restructuring, Information Technology & Outsourcing and Privacy, and Security & Information Management Practices.
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