Personal Guaranties: Know What You’re Signing
Most of us have had to ask a more financially secure family member to co-sign a loan so we could buy a car, farm tractor, or enter into a lease. If you’ve ever been the co-signer, you know that even though you trust your child or family member to pay it off, there’s always that worry you’ll end up on the hook for payments or even the full amount.
As a co-signer, you are responsible for the debt alongside the primary borrower or lessee. But what if you’re asked to sign a personal guaranty instead? A guaranty only makes you responsible for the debt if the primary borrower or lessee defaults on the agreement.
Sounds better, right? Often yes, but depending on the guaranty’s terms you could end up in dire straits. A co-signer is only obligated on the loan or lease agreement they co-signed, while a guarantor may later learn they are responsible for multiple debts.
A recent example from our practice illustrates this. Our client—let’s call him Grandpa—signed a guaranty in 2013 with Bank for debts of a family member’s farm—we’ll call it Farm A. Grandpa assumed whatever later agreements Farm A entered into with other legal entities, such as other companies, would be Farm A’s responsibility, so he did not keep tabs on Farm A’s later indebtedness.
In 2020, Farm A wanted to expand and signed a guaranty with Bank for Corporation B, a beef packaging plant that Farm A’s owners saw as a good way to add value to the cattle it raised. Recently Corporation B fell on hard times and defaulted on its loan from Bank. Bank called its guaranty from Farm A. But since Farm A could not honor the guaranty by paying Corporation B’s debts, and because Grandpa signed an unlimited guaranty for Farm A, which secured all of Farm A’s current and future debts to Bank, Bank asserted Grandpa is also responsible for the guaranty that Farm A signed.
The total amount of this debt? $28 MILLION.
Be Wary of “Unlimited”
The lesson here is not to be scared of signing a personal guaranty—they’re expected for many small business loans—but to know what you’re signing. Many guaranty forms have a statement or checkbox specifying whether it is unlimited or for the specific loan/lease/note being referenced. Almost nobody wants to sign an unlimited guaranty for a business they’re not actively involved with, lest they end up like Grandpa. His situation is frightening enough, but what if Corporation B had signed an unlimited guaranty with Corporation C through the same bank, and so forth? The snowball never stops.
If you have a question about a guaranty you’ve been asked to sign, have your attorney review the document. Here at Ag & Business Legal Services, we spend a good part of our days reviewing all manner of documents, including loan papers, and we would be happy to answer your questions.
You may notice we have referred to leases as well as loans. If you sign a guaranty for a family member to lease a tractor or combine, for instance, be sure you are only signing for that one piece of equipment. If you are not careful, and the primary lessee signs other leases for additional equipment, you could end up guarantying all of them. We have seen claims against lease guarantors for upwards of $3 million, who were unaware of the extent of their liability until the lessor called the guaranty.
Other Terms to Note
There are a couple other terms to watch out for. One is “cross-default provision.” This means that a default on one loan is a default on all loans. In Grandpa’s example, Corporation B’s default on one loan triggered a default on all its other loans from Bank, making all those loans immediately payable—even the ones in good standing.
The other term is “cross-collateralization.” Think of this as the Three Musketeers for loans—collateral for one loan is collateral for all loans. In Grandpa’s case, his home and connected property are now on the line for that $28 million!
Ag & Business Legal Strategies can advise you on guaranties before you sign, and also help with spelling out specific provisions in limited guaranties. Say you are signing a guaranty for a corporate borrower, like a farm corporation. You could seek a provision requiring the bank to exhaust all efforts to collect from the primary borrower before seeking to collect on the guaranty. You could also limit the guaranty to certain debts or a total amount (e.g. only debts owed the day the guaranty is signed, or only up to $500,000).
We can also assist if you find out you’ve already signed an unlimited guaranty. If you’re not intimately involved in the business, then we can help you get the information you need to assess your risk, and if necessary we can help you terminate your guaranty. Terminating won’t help with debts owed before the termination, and it will likely trigger a default, but it can protect you from incurring further liability.
Remember—signing a personal guaranty can be dangerous depending on its terms. You should always be aware of your financial risk before signing.
At Ag & Business Legal Strategies, we want our clients to be honest with themselves and have a solid business plan. Our attorneys and financial strategist will help you create and execute that business plan, and, if necessary, assist you with the legal, tax, and practical aspects of debt restructuring or bankruptcy.
Don’t wait for the problems to become insurmountable. Connect with someone you can trust today, not tomorrow. Contact us here!
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Categories: Farm Business, Financial