Many business owners are more than a little upset when they learn that they are going to be asked to sign an unlimited personal guarantee in order for their business to borrow money. Once they learn some of the reasoning and history behind this requirement, the issue generally settles down. This entry is intended to provide an overall education on the history and reasons a business owner might be required to sign a personal guarantee.
History: After the banking failures of the late 80s and early 90s, Federal and state banking regulators tightened up on banks requiring solid loan documents. This is because many banks during the time were not requiring personal guarantees of their business borrowers. When a business failed, the banks suffered a loss and couldn’t seek recourse against the individual or individuals responsible for owning and managing the business. Certainly most honest business owners don’t intend for their businesses and loans to fail, but during the time there were many wealthy individuals that did not have to repay their company’s bank loans because they had not signed a personal guarantee and they were protected by the corporate veil. As a result, bank regulators adapted a rule requiring banks to require limited or unlimited personal guarantees of any shareholder with over 20% ownership in the company. This 20% ownership rule has more or less been adopted as the standard by private lenders too, even though they are not regulated or required to do so by a regulatory body.
Limited and Unlimited Personal Guarantees: An individual being asked to sign an unlimited personal guarantee is being asked to sign a guarantee that a lender will recover from the guarantor 100% of any outstanding loans made and any and all legal fees associated with the loan. For example, if a business borrowed and subsequently defaulted on a $100,000 loan that cost $10,000 in legal fees to gain a judgment in favor of the lender, someone who had signed an unlimited personal guarantee would be expected to pay back the lender $110,000. If there are several shareholders who have signed such a guarantee, then each one of them are usually held jointly and severally liable. Once a judgment is rendered in favor of the lender, the guarantor’s non-exempt assets can be attached in order to satisfy the judgment. Furthermore the judgment stays on the books in the courthouse until it is satisfied.
A limited personal guarantee is often used when there is more than one shareholder and a shareholder has a smaller interest in the company than the other. The difference is a limited personal guarantee sets a dollar limit that shareholder will be responsible for, instead of making it unlimited. The real effect is that the limited guarantor will always know what the total limit of his financial liability will be if the loan defaults.
Sometimes there are provisions that convert a limited personal guarantee into an unlimited one when borrower fraud is involved.