So you’re an entrepreneur with a snappy idea for a business. You meet with a lawyer and form a limited liability company to protect your assets as you venture into the new enterprise. Next is procuring the financing to get this business up and running. Because your new limited liability company has no assets yet, the lender asks you for a personal guaranty. This is the general practice, so you sign off thinking that your risk is minimal. But what does it really mean to be a guarantor?
When you sign a guaranty you make a promise to the lender to pay or perform the obligations of another person or entity – in this case your limited liability company, the “borrower” – if the borrower defaults.
Guaranties are used in other instances too, such as leases, student loans, vehicles loans and even as part of the admission process for hospitals and nursing homes. The principle is always the same; you are binding yourself to pay if the borrower, tenant, or resident fails to pay.
A guaranty is a contract and as such there is no standard form or limitation on what you promise to pay. It’s very important to read each guaranty closely. The majority of guaranties are absolute, unconditional and unlimited, meaning that your obligation to pay the debt activates the moment that the borrower defaults. The lender does not have to pursue the borrower first, but can immediately look to you as the guarantor for payment of the entire amount owed by the borrower. This may impact your credit report and your ability to get a new loan. A credit provider will ask for information on all debts that you are a guarantor for and may consider the potential loan repayment on the guaranteed debts in assessing whether you qualify for a new loan.
Most guaranties state that the guarantor consents to all renewals, extensions and modifications of the debt requested by the borrower without notice or amendment to the guarantee form. This means that the lender does not have to notify you if the debt is modified or extended. In fact, with an absolute guaranty the lender does not even have to notify the guarantor if the borrower is in default.
A guarantor’s liability will often exceed the amount of the defaulted loan, because as part of the guaranty you agree to pay all fees and expenses of collection and enforcement of the guaranty, including the lender’s attorneys’ fees and court costs.
Once a guaranty has been given, it remains binding until the guarantor gives written notice of revocation. Be advised that revoking a guaranty will not release you from obligations that are outstanding at that time, only from additional obligations that the borrower may incur.
Some guaranties are unsecured, but others are secured by a tangible asset making it easier for the lender to recover the debt. For example, if you secure your guaranty with a mortgage on your home, the lender may commence foreclosure proceedings against you when the borrower defaults. You could lose your home if your new business fails. Furthermore, using your home to secure a guarantee may prevent you from using your home as security for a loan of your own.
In the case where one spouse may sign a guaranty for a borrower, the other spouse may be at risk of losing assets too. In Minnesota you are not liable for your spouse’s guaranty, except under specific circumstances as described in the marital liability statute (Minnesota Statutes §519.05), such as necessary medical services and household supplies. But keep in mind that if the guaranty is secured by your home both spouses will need to sign the mortgage and both will stand to lose the home in foreclosure if the borrower defaults and you cannot comply with the guarantee. In Wisconsin, you are not personally liable for the guaranty of your spouse, but your property can be seized because Wisconsin is a community property state. This applies even in unsecured guaranties where the lender is collecting personal property owned by the guarantor.
While guarantees are a necessary and common component to many financial transactions, it is important to read every guaranty closely to understand your legal liability. If you are unsure about the borrower’s solvency or future ability to make the payments, think twice before you sign that guaranty. Consider whether you can make the payments if the borrower cannot. In any event, signing a guaranty should be considered carefully, because there can be serious consequences for guaranteeing loans. Never assume you know the content of a guaranty without reading it first. If in doubt, consult an attorney before you sign off.
Ms. Seim practices in the areas of real estate and banking at Fryberger, Buchanan, Smith & Frederick, P.A. This article is intended as an informational piece and should not be construed as legal advice. You should always seek independent legal counsel to know your rights and obligations.
