Understanding Risks Unique to Personal Loan Guarantees

Personal guarantees are commonplace in loans of all types and sizes. However, there are issues that are unique to personal guarantees provided by individuals that need to be taken into consideration when negotiating a loan.

 

The death of an individual guarantor typically triggers an event of default on the loan he or she guaranteed. While a lender might agree to a period of time for the borrower under the loan to provide a suitable substitute guarantor, the grace period will be limited (usually 60-90 days) because if no such substitute guarantor is found, the lender must place the loan into default in order to file a claim against the decedent guarantor’s estate. The claim must be filed within 6 months of the guarantor’s death.

 

To avoid probate (and creditors), a guarantor may transfer his or her assets into a trust.  Even if the intent is solely to avoid probate, it also puts the assets beyond the reach of lenders to whom personal guarantees have been provided, as well as other creditors, including any co-guarantors. A balanced approach needs to be negotiated into the guaranty that protects the lender’s interests while accommodating the guarantor’s desire to put his or her estate in order

 

Too often a guarantor that is also a significant equity owner of the borrower, without giving any thought to whether his or her guaranty agreement permits it, transfers small percentages of equity to a child or grandchild or takes other actions to put his or her estate. The lender would then be entitled to call the loan in default.  When negotiating a personal guarantee, a guarantor needs to negotiate carve-outs in the guaranty agreement to allow for some ability to make minimal transfers of equity that do not affect control of the borrower.

 

Co-guarantors have special concerns as lenders are not obligated to pursue all guarantors equally. Plus, if one guarantor dies, the loan may go into default, causing a problem for all of the guarantors. If the decedent guarantor transferred his or her assets out of everyone’s reach into a trust, the co-guarantor may be out of luck in exercising any common law right to obtain contribution. When there are 2 or more guarantors (or even when there is one guarantor but more than one significant equity owner in the borrower, including the guarantor), then a cross-indemnity or contribution agreement should be considered. Any such agreement should include limitations on the transfer of assets that are not at FMV or to a spouse or into a trust. Each party’s estate should also be bound by the terms of this agreement. Other limitations or special disclosure provisions should be considered to help ensure assets are not transferred out of reach of a co-guarantor seeking contribution.  Finally, if one guarantor is more involved in the operation of the borrower’s business than another guarantor, the non-involved guarantor will want to limit any contribution obligations for defaults directly caused by the action or inaction of the involved guarantor.

 

The issues surrounding individual guarantees require special attention but are not insurmountable. With careful drafting of the covenants and other provisions, the interests of both guarantor and lender, plus any co-guarantor, can be balanced to reasonably protect everyone’s concerns.

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