Most organizations take on debt during their formation and during their expansion phase. Even established businesses may need to borrow capital for growth. Large businesses with a history of consistent revenue streams and legal identities separate from owners can apply for and receive credit independently. Loans made to a business will not be enforceable against business owners as long as the business applies for and is granted the loan and the debtor does not make a Personal Guarantee.
However, individual owners can become responsible for business debts for Sole Proprietorship’s, Partnerships and certain other organizational types that do not create a separate identity for the company. Business owners and anyone else who personally guarantees debt can also be jointly and severally liable for debt repayment. Banks can and do enforce Personal Guarantees so it is imperative to understand financial risks of assuming personal responsibility for company debt.
Lotzar Law Firm, P.C. provides assistance to individuals and business organizations on a variety of issues relevant to startups, as well as to expanding organizations. We can review financial transactions and provide advice and guidance on protecting your interests. Before entering into any loan transaction personally or for your business organization, consider having a Scottsdale Arizona business lawyer at Lotzar Law Firm, P.C. review the loan terms to ensure they are sufficiently protective of your interests.
Do Banks Enforce Personal Guarantees?
When you make a Personal Guarantee, you agree to be responsible for all financial obligations of a debtor to a lender in the event the debtor defaults. The secondary obligation supports the primary obligation that exists between a debtor and lender. This obligation is contingent upon the debtor’s primary obligation to repay debts. If the Loan Agreement is declared invalid and the debtor is no longer liable for repayment, the Guaranteer is also no longer responsible for the financial obligation. A Personal Guarantee is distinct from an Indemnity, as an Indemnity creates a primary obligation to repay that is not contingent on borrower obligations.
Guarantees are generally enforceable only if the promise to assume responsibility is in writing and the Personal Guarantee signs the written document evidencing the Guarantee.
Provided the Guarantee is enforceable, banks routinely enforce Personal Guarantees if a debtor becomes unable to pay or is delinquent in repayments. Banks consider the Personal Guarantee when making a risk assessment of the loan and may be induced to lend based, in part, on the credit worthiness of the Guaranteer. Since Guaranteers are required when a primary debtor has insufficient credit or poor credit, lenders count on the fact that they can come after a Guaranteer if the loan is not paid.
Banks and lenders are often quick to begin enforcing a Personal Guarantee as soon as default occurs. Lenders must make a demand for repayment in accordance with the terms of the Loan Documents and must serve the Guaranteer with notice pursuant to contract terms.
Since banks enforce Personal Guarantees, the risk of entering into such an agreement must be carefully evaluated. If you are considering signing a Personal Guarantee to take on debt for your business, speak with a Scottsdale Arizona business lawyer before you sign any paperwork.
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