What is a Personal Guarantee?
A personal guarantee is an individual’s legal promise to repay the debts of a business in the event that the business defaults on the debt. The guaranteeing individual is known as the guarantor, and the entity that the business owes the money to is the creditor.
Personal guarantees are by definition unsecured, which means that they’re not tied to any one asset. Therefore, a creditor can come after any and all of the guarantor’s assets (your home, boat, stamp collection, complete set of Seinfeld DVDs…you get the idea) in order to satisfy the debt. Moreover, the creditor is generally not required to go after the business’ assets first before going after the guarantor’s assets in order to satisfy the debt.
When it comes to small business lending, personal guarantees are the norm. The SBA requires that every owner that owns a 20% or more stake in a business must personally guarantee any SBA loan.
Personal guarantees may not occur as often when it comes to one business extending credit to another, but it’s still a common practice for businesses to include personal guarantee clauses in their credit applications.
Personal Guaranties in Construction
In the construction industry, personal guarantees are popular and can provide an additional option for recovering money due. Generally, a personal guarantee is most likely to be utilized as payment protection when dealing with a new, or small, business, and when dealing with relatively limited credit amounts. This is because a personal guarantee is just what it sounds like, a personal commitment by the guarantor (usually the business owner, or the person signing the contract for credit) to pay any debt incurred under the credit agreement personally in his/her individual capacity if the business defaults on the debt. While this is a large incentive for the business to timely pay the credit amounts received (especially for the guarantor), the ability to get a personal guarantee decreases as the size of the business increases. Also, the personal guarantee is only worth as much as the creditworthiness of the individual signing it — if his/her business is going under will he/she have the money to pay?
That being said, however, there is some benefit to obtaining a personal guarantee in some cases. And, a personal guarantee can be a nice add-on to the protections afforded by mechanics liens, joint check agreements, UCC security interests, and the like. Below I have included a sample policy for the use of personal guarantees, and a sample personal guarantee document to provide some familiarity with potential language. If you decide to follow a personal guarantee policy, it is always advisable to have an attorney draft a personal guarantee clause for inclusion in your credit application or in your contacts that relates specifically to you.
Sample Personal Guarantee Policy:
- Personal Guaratnee is to be built into the credit application/credit agreement. However, this condition for extending credit may be waived or modified for businesses valued greater than $ ______________________, or which have a credit score of ____________ or above, and/or which have been in business for _____________ years or more.
In the circumstances described below, a personal guarantee will be mandatory for the extension of credit.
- Business has a credit score of ___________ or lower, and/or
- Business has a value of _____________ or less,
- Extension of credit sought is ________________ or higher
- No more than two of the following are available to secure the debt: mechanics lien, joint check agreement, UCC lien.
Sample Personal Guarantee Template:
The undersigned agrees to act as a personal guarantor and co-signer to this agreement for all debts incurred both now and in the future for all monies owed by _____________________________, the Company, Persons, or Corporations who have signed this credit application and who have been extended credit both now and in the future. Guarantor recognizes, understands, and agrees that this guarantee may not be revoked or rescinded if any balance remains owed and outstanding to _____________________, the party extending credit, and Guarantor hereby waives his or her subrogation and/or recovery rights.
Further, the undersigned consents to [Creditor] obtaining a consumer credit report on _________ [Guarantor] for the purpose of evaluating the creditworthiness of _________[Guarantor], in connection with an application for business credit.
Guarantor Signature: _________________________________________________ Date: _________
Guarantor Printed Name & Social Security Number: _____________________________________
What’s Better: a Personal Guarantee or Lien Rights?
Let’s get right down to it. For construction companies that extend credit to their customers, is it better to have lien rights or a personal guarantee? If you think that dealing with mechanics lien compliance is too challenging, is it sufficient to just collect personal guarantees?
In one word, the answer is ‘No.’
That’s because I firmly believe lien and bond rights offer much, much more security than a personal guaranty, because when it comes right down to it, a personal guarantee is only as good as the person signing it.
The mechanics lien or bond rights provide the absolute best security for a company extending credit to a construction project. If the account is unpaid, you open all types of options to get you paid and the underlying claim is secured by the property itself. Lien claimants can enforce their claim in court, forcing a sale of the underlying asset in order to satisfy the debt. With a personal guarantee, you are limited to just going after the guarantor’s assets, and they have the (somewhat drastic yet still viable) option of declaring personal bankruptcy to limit the guarantee’s potential recourse.