Given the wide use of personal guarantees in the construction industry, let's take a look at how they are interpreted and handled by the courts. Let's also discuss your risks if you signed a personal guarantee and are a "guarantor," guaranteeing payment of a company's debt. Let's also take a look at what your remedies are if you are holding a personal guarantee signed by someone else for a debt owed to you.
At the outset, I need to make my usual refrain, which is that the laws can vary from state to state. So, while I can generalize and help sensitize you to the various rules and requirements on personal guarantees, you have to determine which state's law covers your transaction to best protect your rights. Sometimes that may be easy since the language in the personal guarantee may specifically say that it shall be governed by the laws of a particular state.
What Are Personal Guarantees?
As you are no doubt aware, personal guarantees are common tools used by creditors and lenders under a wide variety of circumstances affecting companies at all levels in the construction industry. Banks rarely will offer a substantive credit line unless personal guarantees from the individual company owners are signed. Suppliers who offer credit lines to contractors and subcontractors normally do so only if the principal of the company signs a personal guarantee. Landlords normally do not write commercial leases without some form of personal guarantee. (You've probably heard of the personal guarantees in real estate referred to as "Good Guy Clauses," which can make the individual guarantor liable for varying portions of unpaid rent for a company's lease term.)
Bonding companies normally will not agree to issue performance bonds or labor and material payment bonds unless the individual owners of the construction company sign a personal guarantee, normally contained in the master surety agreement. Over the years, I've found these situations to be a bit more delicate since bonding companies typically want the principal of the company and his or her spouse to sign the personal guarantee. Spouses seem a little more reluctant to sign, especially if he or she has nothing to do with the construction business and realizes that the home can be on the line if there is a default.
Common Concerns Surrounding Personal Guarantees
Given the wide use of personal guarantees in the construction industry, let's take a look at some common issues and questions that arise concerning them.
Know Your Coguarantors
If a lender or creditor requires personal guarantees from more than one person, make sure you are comfortable and can trust the other guarantors and that they have the means to share in any loss. Generally, personal guarantees provide for "joint and several" liability. That means that the whole group is liable together (joint liability shared equally) and that each individual is personally liable (several liability) for the entire unpaid amount as well.
For example, if you have three partners who are also owners of your company and everyone signs a "joint and several" personal guarantee for a suppliers credit line, all four of you are liable together for any unpaid amounts due from the company (obviously broken down as 25 percent per each guarantor). However, since there is "several liability" as well, each owner/partner guarantor would be liable individually for the full amount of the debt if the company is in default in making payment to the supplier. Any individual guarantor who is forced to pay the full amount would then have to make a claim against the other three owners/partners for the pro rata reimbursement.
So, before you sign a personal guarantee with others, consider this: If you have to pay the full amount personally, will your partners reimburse you for their respective shares? What happens if the partnership ends? While you can agree with your partners or co-owners among yourselves about what happens on the termination of your company, the personal guarantees that each of you signed before the split will survive the breakup. Upon termination, it is not up to you or your co-owners/partners what happens to those personal guarantees—it is up to the lenders and creditors who obtained the personal guarantees before the split to cancel or adjust any personal guaranty. And, let's face it, after the owners or partners in a company split up, why would a creditor or lender agree to cancel a personal guaranty that was given before the split?
I mentioned above the situation where a husband and wife are both required to sign a Master Surety Agreement in which they both are guarantors for the bonding company and agree to reimburse the bonding company for losses on any of the bonds underwritten by the bonding company. We've had a few cases where the principal of the company and his or her spouse sign a personal guarantee, but they then separate or are divorced. However, the personal guarantees will remain active even after a separation or divorce, which could give liability to one of the spouses long after the separation or divorce. It becomes a hard pill to swallow for the former spouse who was not directly involved in the business to accept that he or she is still liable on the personal guaranty for any losses incurred in connection with any of the bonds issued by the bonding company, notwithstanding the separation or divorce.
Know When You're Responsible for Payment
A lender or creditor may not have to try to collect from the underlying debtor/company before going after the guarantor. I concede that I have always found this troubling. I always considered a personal guarantor a "last resort" for payment (i.e., that the individual guarantor only should be liable if the original debtor defaults, then is sued and still does not (or cannot) pay). However, no one seems to care about my feelings. Thus, in certain instances, the law will not require the lender or creditor to make every effort to try to collect from the original debtor before attempting to collect from the individual guarantor. The issue turns on whether the personal guarantee that was signed is a "guarantee for collection" or a "guarantee for payment."
If the guarantor signed a "guarantee for collection," then the lender or creditor must first make diligent efforts to try to collect the debt from the original debtor before the lender or creditor can start a lawsuit against the personal guarantor. If the guarantor signed a "guarantee for payment," then the lender or creditor can make a claim against the personal guarantor immediately after there is a default in payment. The lender or creditor does not first have to make any good faith efforts to try to collect from the underlying debtor before they can sue the personal guarantor.
Courts Chime in. An older, leading case decided by New York's highest court explains it the following way.
Whether a surety is a guarantor of payment or a guarantor of collection depends upon the intention of the parties as expressed in the surety contract. If he binds himself to pay immediately upon default of the debtor, he becomes a guarantor of payment; if he binds himself to pay only after all attempts to obtain payment from the debtor have failed, he becomes a guarantor of collection.… A contract of suretyship does not depend upon the use of technical words but upon a clear intent that one party as surety binds himself to the second party as creditor to pay a debt contracted by a third party, either immediately upon default of the third party or after attempts to effect collection from the third party have failed.
General Phoenix Corp. v. Cabot, 300 N.Y. 87 (1949)
Another court in New York says, "Where a guaranty is one of collection, the creditor must, in order to collect from the guarantor, show not only that he has taken legal action against the principal [original debtor] and has been unable to collect, but also that he exercised "due diligence ... in enforcing his legal remedies against the debtor." Mullan v. Randall, 100 A.D.2d 737 (4th Dept. 1984.)
A Florida court recently held similarly, saying: "A contract of guaranty may be absolute or it may be conditional." In the absence of limiting terms like "if," "provided that," or "on condition that," "whether a certain contractual provision is a condition, rather than a promise, must be gathered from the contract as a whole and from the intent of the parties." When a guaranty makes payment premised upon a demand, the demand is a condition precedent. Nabbie v. Orlando Outlet Owner, LLC, slip opinion, Case No. 5D16-1146, Fla. Dist. Ct. App., Feb. 9, 2018.
We had a recent case that I am guessing, unfortunately, is a bit close to home for a number of us. Our client was the owner of a construction company. His parents had to be placed in an extended care facility. The facility's agreement said that the parents would be liable for the cost. However, the facility also required the client to sign a personal guarantee, guaranteeing payment once the parents' assets were exhausted. As happens, the parents' assets were used up. The facility then sued our client for the unpaid charges and claimed that he was liable since he signed a personal guarantee for payment.
We defended by saying that the contract, drafted by the extended care facility, stated that the facility would attempt to obtain payment from outside sources in addition to applying the parent's assets toward any open charges. We argued that the language saying that the facility would attempt to collect from other sources made the guarantee one "for collection" and not "for payment." As a result, we argued, before the facility could sue our individual client on his personal guarantee, the facility had to show it tried to obtain payment from other sources. However, it was clear that the facility had not made any effort to collect from outside insurers that likely would have paid the charges at the time. The court agreed with us and dismissed the case against the individual client. Unfortunately for the facility, since they failed to make a timely request to the applicable insurers, it was too late for them to collect from those insurers either.
Is the Personal Guarantee Enforceable?
Personal guarantees generally must be in writing and signed by the individual who will be making the guarantee. Many states have what are known as Statutes of Frauds. Those statutes require certain documents to be in writing and signed for a claim to be enforceable. Typically, an agreement to answer for the debt of another entity must be in writing and signed to be enforceable. If it is not, then the personal guarantee is not valid.
Corporate Officers Can Be Held Personally Liable
A corporate officer can be personally liable as a guarantor even though he or she signs as "Pres" or "Vice Pres." There are some recent cases also in Florida that make it clear that a corporate officer may be deemed a guarantor of his or her company's debt even though an agreement is signed by the officer as president or vice president. In those cases, the courts noted that, although the corporate officers wrote in the words "president" or "vice president" next to their names and on the signature blocks, they were still liable as personal guarantors because of the specific language in the agreement they were signing.
In each case, the main body of the agreement stated that the individual signing the agreement agreed to assume responsibility as a personal guarantor of any debt that was not paid by the company. As a result, the courts found each officer personally liable as a guarantor of his or her company's debt. The courts said that the language in the document made it clear that the officer agreed to be a guarantor of the company's payment obligations and that simply writing "Pres" or "VP" next to the signature did not change the clear language in the agreement. The court also noted that, if the officer was deemed to be signing only as an officer, then the personal guarantee language in the agreement would have no effect, and the corporation, in essence, would be guaranteeing payment of its own debt—which the court said made no sense. See Great Lakes Products v. Wojciechowski, 878 So.2d 418 (Fla Dist. Ct. App. 2004).
Know the Amount Guaranteed
A guarantor can be liable for more than the amount owed by the company. Language in personal guarantees typically makes the personal guarantor liable for the unpaid company debt, plus all related collection costs and interest. As a result, the personal guarantor can be responsible for a significantly higher amount than was owed by his or her company.
We had a case in the early 1990s in upstate New York, where we represented a contractor that had a credit line with a local supplier. The company owner signed a personal guarantee but clearly stated that the guarantee was limited to the amount of $90,000. The contractor owed almost $200,000 for unpaid supplies on a major upstate construction project. The supplier then sued the company owner personally on his personal guaranty. The court found the individual company owner liable for the full amount, even though the personal guaranty was limited to $90,000.
I confess to having a senior moment and not being able to understand how or why the court held that way. I cannot find the decision, but it has always stood out to me. Whether it was a case of "home cooking" for a local supplier or sheer incompetence of a local judge, it was an outrageous result. I point it out just as an alert—so that, when necessary, you make clear the limits of the extent of any personal guaranty and, more importantly, try to avoid courts doling out some home cooking with incompetent jurists.
So, what does this all mean? The options that you have relative to personal guarantees, obviously, depend on whether you are in a position of a lender/creditor requesting a personal guarantee from an individual owner or whether you are the principal of a company that can only get credit if you sign a personal guarantee. If you are a lender or creditor—as, for example, a supply house—then you want a personal guarantee from the principals of your customers. You will need to be sure the language in the personal guarantee is clear and that it is signed by the principal in his or her personal capacity. Be sure that the personal guarantee is one "for payment" and not "for collection" since that will save you a bunch of time and effort if there is a default in underlying debt.
In contrast, if you are asked to sign a personal guarantee, try to negotiate one that is "for collection" and not "for payment" and, therefore, forces the lender/creditor to try to collect from the underlying debtor first. Make sure the limits of the guarantee are clear so that you know the extent of your risk. Granted, with large lenders or large bonding companies, you may not be able to make any changes to their boilerplate personal guarantees, but it may be worth the effort to try.