2011 June 20 by Andrew Savard
Would you go to Vegas, belly up to a roulette wheel and bet the deed to your house, your retirement account and your personal savings and assets on Red? Probably not. But that’s not a far cry from signing a personal guarantee when you sign a franchise agreement.
Requiring a corporate (or LLC) franchisee to sign a personal guarantee has become the norm. It’s not without reason. Franchisors are concerned that franchises which are newly formed corporations (or LLCs) can too easily file bankruptcy to get out of their obligations if the franchise does poorly – leaving the franchisor with nothing. So, by requiring a personal guarantee from the officers or shareholders of the corporation (or the members of the LLC), the franchisor gets a little of the franchisee’s “skin in the game.”
However, signing such a personal guarantee frustrates the whole purpose for establishing the corporation (or LLC) in the first place – to shield your personal assets from the debts and obligations of your business. The good news is that as long as you adhere to the required corporate (or LLC) formalities, this “side-stepping” of the legal liability protection will only apply to the franchisor. It will not allow the rest of the world (i.e. customers, employees, the general public) to seek damages against you personally. But, as to the franchisor, you’re betting it all on Red.
What can be done? First and foremost, have a franchise attorney review the franchise agreement, the personal guarantee and any other agreements required by the franchisor. Even if you don’t have a separate personal guarantee, comparable language can often be found couched in the text of the franchise agreement itself. Not uncommonly, franchisors will require that you sign the franchise agreement as an individual (thereby putting you personally on the hook for all of the obligations therein), and then transfer ownership/operation to your corporation (or LLC). The transfer agreement may very likely contain language specifically stating that you, the individual, are not relived of the obligations to which you agreed, regardless of the transfer. Personal guarantee language can also pop up in agreements to sell or transfer ownership to a third party, if you decide to sell your business. In no circumstance should you agree to guarantee the performance of a buyer of your business!
Once reviewed, you can try to negotiate the language and terms of the guarantee, or try to have it eliminated in its entity. Setting caps on recoverable damages, creating a list of “off-limits” assets, or even an expiration date for the guarantee are just a few options. Unfortunately, with most franchises, the agreements are “take it or leave it.” In that instance, you need to take what few steps you can to insulate your personal assets from the risk of exposure to your creditors, namely the franchisor.
In most states, you can file for a Declaration of Homestead for your primacy residence (some states apply this protection automatically by law). This will protect the equity value in your home, up to a set amount (i.e. in MA, your home is protected up to $500,000 if you file; $125,000 if you do not), and prevents a creditor from forcing the sale of your home to pay off your debt. Additionally, you can put investment or vacation properties into Real Estate trusts or Real Estate holding companies. Additional businesses that you may own should be held by separate business entities (corporations or LLCs).
In the end, your best bet is to avoid signing a personal guarantee whenever possible.
If you need more information or assistance with a franchise agreement, personal guarantee or other business contract, please call our office for a free initial consultation. 781-333-4182 Or visit us on the web: www.SigmanLaw.us