2014 July 21 by Andrew Savard
Many business owners looking to borrow money, buy a vehicle, invest in a franchise or sign a commercial lease are faced with the prospects of having to execute a personal guaranty. This is a difficult decision when the business owner weighs the advantages or necessity of the opportunity against the potential liability exposure associated with the personal guaranty. What’s at stake for the business owner? Everything essentially.
Most business owners set up the business on a strong legal foundation: they set up a corporation or LLC; purchase liability insurance coverage; review the applicable state and federal statutes regarding licensing, operating and owning a business in their industry; and making sure that their agreements with vendors and customers/clients are solid. This foundation is built with the goal of minimizing liability exposure both for the business and for its owners.
The personal guaranty erodes this liability protection, particularly with respect to the protection provided by a business entity. A corporation or LLC affords the owners with a liability shield and therefore a separation between their business and personal assets. The personal guaranty is a promise by the owners of a business that forfeits this protection. The bank, landlord or other creditor does not have to look solely to the assets of the business to satisfy any claim that they may have against the business owner should the business default on its obligations. The creditor can go right after the personal assets of the owner directly.
The problem is that in order to achieve many of these goals (i.e. having a space to operate the business, borrow money, purchase a franchise, etc.), the business owner is required to sign a personal guaranty. While it is never advisable to do so, many business owners have no choice in the matter. The good news is that there are sometimes strategies based upon the negotiating power of the business owner which can help mitigate the risks. These include limiting the scope or duration of the guaranty. For example, in the case of a commercial lease, an unlimited guaranty can be toned down such that the business owners are only responsible for the initial term of the lease or only to the extent of the actual rent owed to the landlord (i.e. it excludes attorneys fees, costs, and interest).
It is imperative that a business owner faced with this decision obtain appropriate legal advice prior to signing a personal guaranty. Given what it at stake, a few minutes on the phone or in a meeting with an attorney can potentially save the business owner thousands of dollars in personal exposure..