Limiting Liability in a Personal Guaranty
Most commercial landlords and lenders require personal guarantees from their tenants and borrowers. Small business owners often believe they have no other option than to agree to the terms of the personal guaranty agreement provided to them by the landlord or lender. However, in these troubled economic times, landlords and lenders have fewer attractive prospective tenants and borrowers, giving tenants and borrowers more leverage to negotiate favorable terms.
It is important to understand that even if a lease or loan is made in the name of the corporate entity, the limited liability protection afforded by these entities is eliminated once a personal guaranty is signed. In other words, even if an entity goes bankrupt, landlords and lenders can pursue the owner’s personal assets if she signed a personal guaranty. Most standard landlord-friendly personal guarantees have provisions that protect the landlord even if the tenant files for Chapter 7 (personal) bankruptcy. Therefore, a small business owner tenant can be stuck paying a high price tag for a bad business venture for years to come.
So how can a business owner manage the risk or minimize potential personal liability?
First, as a business owner, one needs to understand why the landlord or lender wants the guaranty. The reason the landlord or lender wants a guaranty is because the guaranty ties the business owner to the obligation and makes her more invested in her business. If the business owner has strong credit, operates more than one successful business, or the business has sufficient assets to cover the amount of the loan or lease, this may persuade the landlord or lender to forgo the personal guaranty. A business owner must keep in mind that guarantees are difficult to negotiate unless there are alternative lending or leasing options that the business owner can seek. A business owner should not blindly limit her options by committing to one location or one lender. If a business owner can keep her options open, she will have better leverage to negotiate the terms of the personal guaranty.
If the landlord or lender insists on a personal guaranty and the business owner is in a position to negotiate, the business owner should consider the following tips. A business owner should negotiate a realistic dollar amount or loan percentage for which she would comfortably be willing to pay personally. A business owner should negotiate a time limit on the guaranty. For example, it is possible to include language that reduces the overall guaranty amount over a course of time as long as timely payments have been made. Avoid having a spouse who is not a business owner sign the personal guaranty. Include a provision that allows another individual to substitute for the small business owner as the personal guarantor. Also, have each business partner sign as a guarantor so that as individuals each partner can share in the potential liability.
Negotiating with landlords and lenders can be very difficult. The tips included in this short article are just a few items that should be considered when negotiating a personal guaranty. An experienced lawyer can help negotiate the terms of these agreements to mitigate potential personal liability. Keep in mind that when it comes to legal advice regarding the negotiation of personal guarantees, there is no one size fits all advice. Rather, the advice needs to be tailored to individual circumstances.