Getting your startup business off the ground can be a challenge. One of the greatest barriers facing business startups is obtaining financing. Without enough collateral to secure loan obligations, a bank might require a personal guaranty before it agrees to approve a loan for your business. While banks, financing companies, or other loan underwriters will always attempt to collect on a personal guaranty, there are certain circumstances where a personal guaranty may simply be unenforceable.
What is a personal guaranty?
A “guaranty” is a promise to answer for the payment of another person’s debt if that person fails to make payment in the first instance. One who promises to fulfill a guaranty is called a “guarantor.” For example, a parent who agrees to co-sign for their child’s car or their student loan is the guarantor of those obligations. In the case of your business and its application for financing, your personal agreement to repay the loan if your business cannot do so means that you’ve given a personal guarantee.
What liabilities are you assuming when you sign a personal guaranty?
When you sign a personal guaranty on behalf of a business, you agree to be personally responsible for repaying the business’s creditors in the event that the business itself becomes unable to do so.
Here’s a scenario that could play out:
- Your business needs equipment to manufacture and sell widgets.
- Your business applies for a loan to buy that equipment. The equipment your business purchases is pledged as collateral to secure the loan obligation, and the bank takes a security interest in it; the loan agreement may also require you to personally guarantee your business’s obligation to repay the loan.
- Unfortunately, your business fails, and you can’t make payments on the debts as they come due.
- The bank sues your business for defaulting on its payment obligations, and you are individually named as a party in that lawsuit because you are a personal guarantor.
- You will be personally liable to the extent that the value of the collateral is insufficient to cover the outstanding loan obligation.
When you sign a personal guaranty for your business to receive a loan, you pledge your personal assets as collateral, including your home, the cash in your personal checking account, your savings and investments, and your future wages, which the bank will attempt to garnish.
Note that some insurance products may provide coverage for losses sustained from personal guarantees. Consult with your insurance agent for more information.
Factors influencing the enforceability of a personal guaranty
Personal guarantees are a requirement of many business contracts. Entrepreneurs and business owners should understand the potential consequences of signing one. It may also be helpful to understand whether an argument against the enforceability of a particular personal guaranty exists. Even large banks or other institutions sometimes overlook fundamental requirements.
The personal guaranty must be evidenced by a written instrument
In Ohio, any agreement to answer for the debt of another person must be evidenced by a written instrument (See R.C. 1335.05). If your business receives demand correspondence alleging that you have personally guaranteed your business’s debts, demand a copy of the written instrument allegedly evidencing the personal guaranty. One who seeks to enforce a contract of course bears the burden of proving that it, in fact, exists.
The written instrument must be signed by the guarantor in the guarantor’s personal capacity.
To be enforceable as a personal guaranty, the signatory must sign the guaranty in his or her personal capacity and not as the “president” or “CEO” of the company receiving the loan, which is its own legal entity, separate and apart from the people that run and operate it.
If the personal guaranty is not evidenced in writing, and if such writing was not signed by the alleged guarantor in his or her personal capacity, then there are strong arguments against its enforceability.
A personal guaranty is unenforceable without adequate consideration.
In fact, no contract is enforceable without adequate consideration. A personal guaranty is a type of contract. A contract is an enforceable promise. The enforceability of a contract comes from one party’s giving of “consideration” (something of value) to the other party. In the case of a loan agreement involving a personal guaranty, the bank gives a loan (which is valuable to the business applying for it) in exchange for the guarantor’s promise to repay it (which is valuable to the bank as a hedge against default).
In a lawsuit to collect a debt, a creditor must prove that it has the right to collect the alleged debt. As mentioned above, some creditors simply cannot produce documents evidencing their alleged right to collect; this may be attributable, at least in part, to the number of times that loans are repackaged and resold.
Can a personal guaranty be revoked later?
An otherwise valid and enforceable personal guaranty can be revoked later in several different ways. A guaranty, much like any other contract, can be revoked later if both the guarantor and the lender agree in writing. Some debts owed by personal guarantors can also be discharged in bankruptcy.
Many factors can affect the enforceability of personal guarantees. If you have any questions about the enforceability of a personal guaranty that you have signed, or if you are considering signing one to get financing approved, please consult with one of our experienced Ohio business law attorneys who will assess your case and offer thoughtful legal guidance to support your decision.
Maximilian Julian is a partner at Gertsburg Licata. He may be reached at (216) 573-6000 or at mjulian@gertsburglicata.com
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