Before You Personally Guarantee a Business Loan, Read This

Most small businesses owners have borrowed money to start and grow their businesses and, in most cases, had been requested by the lender to personally guarantee those debts. Sometimes the lender also requires the spouse to guarantee the debt, even if the spouse has nothing to do with the business.

In a loan context, a guarantee is a promise to pay the debt if the borrower is unable to do so.

In a business loan context, a personal guarantee is the promise of an individual, often the business owner, to pay the debt if the business is unable to do so.

Why is it important to pay attention to these personal guarantees?

Because starting and growing a small business is risky. If the startup fails, the personal guarantor is on the hook for those debts. All of the guarantor’s assets can be seized by the creditor once it obtains a judgment against the guarantor.

Why is it important to pay attention to a request that the spouse guarantee the debt?

Because when in Missouri a husband and wife own an asset together, such as a home or joint bank account, it is said to be owned as “Tenants by the Entirety” or TBE. In Illinois, TBE ownership is limited to homes owned by married couples.

TBE ownership is different than joint ownership. If two owners of an asset aren’t married, creditors of only one owner can reach that owner’s interest in the asset. With TBE ownership, however, only creditors of both owners can reach the asset. Obviously, it is to the business owner’s advantage not to have the spouse on the guarantee. This prevents the lender from seizing the jointly owned asset should the business fail.

Federal law protects a lender from demanding a spouse’s signature unless the spouse is a partner, director, or officer of the business or a shareholder or member. Regulation B, a provision of the Equal Credit Opportunity Act, provides that a lender cannot demand the signature of a spouse who is not involved in the business if the applicant qualifies for credit without the spouse’s guarantee and the spouse is not a joint applicant. Before your spouse signs any loan documents, be sure to consult with your attorney to ensure that a spousal signature is not required.

Should your business fail, and the lender tries to enforce the guarantee, your attorney should review the loan documents to determine if you have any defenses to the guarantee. For instance, a lender cannot enforce an “embedded guarantee,” in which some provision in the loan document itself states that the owner’s signature as a representative of the borrower also serves as a personal guarantee of the loan personally. These are not enforceable.

Because of the risk inherent in signing a personal guarantee, a separate individual signature underneath the terms of the guarantee is required for the guarantee to be effective. This can be either in a separate portion of the loan document or in a stand-alone guarantee document.

Can I limit my risk under a personal guarantee?

Yes, you can, to the extent that your lender will allow it. Here are some examples:

1. Ask for limits on the assets that can be reached if the guarantee is enforced. You could request that certain assets not owned as TBE be excluded, such as your home or other real estate, a savings account with your child’s money in it, or any other asset of personal importance to you.

Most retirement accounts are exempt from the reach of creditors, either by federal law or Missouri statute. Missouri also provides for an exemption of some of the equity in your home, but it is very small, and not enough to dissuade a foreclosure.

2. Ask for limits on the dollar amount of your guarantee. There are several ways to accomplish this:
   1. Offer to pay a higher interest rate in exchange for not giving a personal guarantee.
   2. Simply ask for a limit. Try to avoid open-ended guarantees. If your company is borrowing $1,000,000 and the debt is secured by collateral worth $750,000, ask that your guarantee be limited to $250,000.
   3. Ask for the amount of the guarantee to be decreased over time or when certain thresholds are passed. Over time, you hope that your business will thrive and grow. Presumably its creditworthiness will improve. Ask for a provision that reduces after two or three years of timely payments, when revenue increase above a certain value, or when its debt to asset ratio falls below a certain level.
   4. If your business has several owners, ask that your guarantee be limited to the extent of your ownership interest.
   5. Ask to simply pledge additional collateral in lieu of a guarantee. Often a business owner will offer to pledge something capable of easy liquidation, such as a Certificate of Deposit, instead of a guarantee.
3. Don’t agree to a waiver of defenses. Many guarantees call for the guarantor to waive all of their defenses to liability. Don’t do it! State and Federal laws are there for a reason. If the lender failed to follow them, then they shouldn’t be able to avoid the result of their errors.

So don’t just roll over when a lender asks for a personal guarantee, especially if the guarantor is your spouse. If you are unable to avoid guaranteeing the debt, try limiting it as suggested above. If the guarantee is called, see if you can defeat its enforceability.

Best of luck with your business!

Posted by Attorney A. Thomas DeWoskin. DeWoskin practices in the areas of bankruptcy, creditor’s rights, and commercial law. He represents creditors, as well as business debtors, and individuals with difficult or unusual financial situations. DeWoskin served as a bankruptcy trustee in the Eastern District of Missouri for more than 35 years. 

Published in the March 2023 St. Louis Small Business Monthly.