Small Business Owners and the Personal Guaranty - How Can You Avoid Liability?
/The easiest method of avoiding personal liability for a debt as a small business owner is to never sign a personal guaranty. However, banks and other institutional and private lenders are mindful that most start up businesses, entrepreneurs, and young businesses have very few valuable assets, thin capital, and unpredictable revenues to obtain sufficient security when issuing a loan. In other words, it is nearly impossible for a small business to obtain a loan without providing the lender the security of a personal guaranty in addition to other commonly used types of security, such as a collateral assignment of leases and rents, security agreement and UCC- 1 Financing Statement ("UCC-1"), or a mortgage on the commercial property, and, sometimes, the owner's personal residence.
It is all too common an occurrence that when a business owner decides to exit the business, wind down operations, or sell the assets of the business to a third-party, the personal guaranty may become a significant issue. For example, if a business debt is owed to a bank for a commercial loan, and the business owner or partners decide to terminate business operations while the debt remains unpaid, it is highly likely that the bank will demand payment from the guarantor under the terms of the personal guaranty. As another example, a business owner may be personally liable on a loan or lease agreement, and the assets of that business are being sold to a third party. Not only does this create an issue if the bank holds a UCC lien on those assets, the question arises, for the business owner, as to how the debt will be satisfied so that he/she may be released from the obligations of the personal guarantee. No business owner should sell a business or its assets, and remain personally liable on any of the business debts, particularly if the debt is tied to those assets.
How does a business resolve the liability associated with a personal guaranty?
The easiest way to manage a personal guaranty is to make payment arrangements, or negotiate a payoff of the debt and release of the guaranty. In this instance, the lender will look for cash and may be willing to accept some type of equity or other type of security as consideration. It all depends on the circumstances, as well as the viability and nature of the acquiring business.
The other method of dealing with a personal guaranty is litigation. If you fail to pay a debt upon reasonable demand of the lender under the terms of the personal guaranty and promissory note, then it is likely that you will be dragged into a state court legal proceeding. Litigation is costly, time consuming and expensive for all participants. If you are defending the enforcement of a personal guaranty, the best method of defense is equitable principals. In this instance, you are relying on the lender's acts and omissions during loan issuance and administration to provide you with an equitable defense to enforcement. For example, has the lender negligently handled the loan by failing to notify the guarantor of material changes in the loan, such as loan amounts, credit line increases, term, and the like? Did the lender take actions that indicate that it waived its rights to enforce the guaranty, or did it enter into another agreement that satisfies the debt, in full or part? Did the lender fail to adequately provide adverse information concerning the business financial affairs that somehow increased the guarantor's risk? Did the lender allow the default and permit the debt to accumulate interest and principal? These are all questions that any Boston area business owners should ask when faced with a personal guaranty.
There also may be issues with the personal guaranty document itself. The document may fail to properly identify the parties; capacities in which the parties have signed; failure of consideration; the guaranty could be a payment guaranty or a collection guaranty; or some other type of technical issue with the personal guaranty. However, it is highly likely that lenders have learned from mistakes of their own, mistakes of others, and/or have hired skilled lawyers to draft the personal guaranty. In this instance, the best hope for some type of technical issue is that the lender obtained the guaranty from an unqualified attorney or used downloadable form obtain from an Internet legal form retailer.
Finally, there is reorganization and/or liquidation in a bankruptcy proceeding. This is typically the final option for most business owners, and is not desirable for those wishing to keep their financial affairs out of public view, and out of the hands of a bankruptcy trustee.
As outlined above, there are narrow circumstances that permit a Massachusetts business owner to avoid personal liability for a business debt and/or personal guaranty. If you or any business owner or a group of business partners have questions about liability under a personal guaranty, Attorney Stefan Cencarik, a business lawyer serving the Boston area, is available for consultation at 617-669-9780.