Personal Guarantees, secured loans, and unsecured loans are commonplace in business. What are they?
Personal guarantees are sometimes viewed as anathema by the business owner. Yet, in many cases, a creditor will insist on a personal guarantee with the business owner (and his/her spouse to circumvent the tenancy by the entirety problem) before executing a loan, lease or contract. The personal guarantee, if drafted properly, will ensure that the creditor may recover from your personal assets/estate, not just your business entity, in cause of default. It is, then, a layer of assurance ensuring you cannot skip out on your obligations and leave the creditor with the sole recourse of foreclosing a debt on an insolvent business. When construing personal guarantees, attention to the specific language of the document is paramount. The extent, triggering clauses, and duration of the guarantee need to be ironed out. One must approach personal guarantees with caution given the amount potentially on the line, especially if you are a third party personally guaranteeing another individual or entity’s contract/debt (e.g., a cosigner).
Aside from personal guarantees, “secured” loans are another way creditors are able to collect/guarantee debts. The distinction between an unsecured debt and a secured debt is that an unsecured debt does not have any collateral or personal property guaranteeing performance in case of default; secured debts, on the other hand, have property which can be recovered in case of default. In other words, for a secured debt/loan, one party buys something from the creditor but does not pay immediately. The creditor would love to rely on your good faith and promise to pay, but wants something more to ensure payment. A “security” interest is a limited, contingent right in your personal proeprty which triggers upon breach of contract– or upon the occurrence of a stated default event spelled out in the loan and/or security agreement.
Business owners, particularly those involved in equity and debt financing, need to be intimately familiar with the foregoing. If you have questions pertaining to secured/unsecured loans and personal guarantees, or the negotiation, mechanics or prosecution thereof, contact us for help.