Over the past number of years, there has been increasing litigation over the enforcement of commercial guarantees by lenders across the country. As more and more primary borrowers either default on their loans or file for protection under federal bankruptcy law, the existence of an enforceable personal guarantee is often the only way a lender or creditor can avoid going home empty-handed. Given the importance of these instruments, it is surprising how many lenders fail to properly structure the language in the guarantee to fully protect their interests.
What is a Personal Guarantee?
A personal guarantee, sometimes spelled as guaranty, is a promise to answer for the payment of some debt or the performance of some duty by another person, should that other person fail to follow through on their promises.
The party making the personal guarantee is often referred to as a co-signor or a guarantor. The direct debtor who made the agreement covered by the guarantee is the principal.
Before there can be a guarantee there must be a primary debt obligation. In the context of a loan transaction, for example, a guarantee serves as a form of collateral to support the underlying primary debt obligation between the debtor and the creditor. However, the guarantee and the underlying loan agreement are separate legal obligations and are not consolidated simply because both of the agreements are written on the same instrument or executed concurrently.
What are Some Examples?
There are plenty of examples of personal guarantees in both the world of business and in day-to-day life. Some common ones are:
- Personally guaranteeing payment for the delivery of goods or services for your business
- The owner of a small business signs a personal guarantee to secure a business loan or business credit
- Co-signing a child's application for student loans for college
These guarantees come in the following forms:
- Absolute or conditional guarantees – the guarantor will perform the obligation, should the principal default
- Conditional guarantees – the guarantor will perform the obligation, should the principal default and some other event occurs, like the creditor exhausts all of its remedies against the principal
- Continuing guarantees – the guarantor's promise to stand-in for the principal applies to multiple transactions, including those that may happen in the future
Whatever form a guarantee takes, Massachusetts law strictly enforces guarantees and construes and enforces each guaranty according to its plain language. The reason behind this rule is that public policy favors the enforcement of these instruments so as to provide certainty in business relationships and to ensure the free flow of credit.
How to Structure an Enforceable Guarantee Agreement
There are 9 ways for a creditor to better ensure that their guarantee agreement that will be enforceable:
- The guarantee is in writing and accompanies the text of the underlying agreement
- The guarantee is separated from the rest of the underlying agreement, with its own signature lines and acknowledgments
- If the creditor wants to pursue the guarantor for reasonable attorney's fees, costs and expenses in the event of collection, then language to that effect is explicitly stated in the text of the guarantee
- The guarantor signs and prints his or her name, preventing them from making the common claim that the signature is not their own
- The principal signs both the underlying agreement and the guarantee agreement
- The guarantee explicitly states that the guarantor accepts “absolute and unconditional liability” for the debt
- The creditor engages in due diligence concerning the guarantor
- The guarantor agreement includes a provision that requires the guarantor to waive certain rights
- Once the agreement is signed, the creditor enforces its terms
Several of these aspects demand further explanation.
Do Your Due Diligence on the Guarantor
Oftentimes, companies will spend the requisite time to research the creditworthiness of the principal borrower and completely forget to do the same with respect to the guarantor.
This is a huge mistake.
Remember, the guarantee is only as good as the person signing it. Have the guarantor submit a separate credit application and put that application through your company's usual credit process. Another reason to "vet" your guarantor is that many guarantors, particularly in the construction business, guarantee multiple obligations at the same time. A guarantor's multiple obligations can often put them in a state of economic peril when it comes to potentially paying on all or some of their obligations.
Put another way, just because you have a guarantee does mean that you are guaranteed payment. You must do your due diligence when it comes to the background of any guarantor. You might be surprised at what you might find!
Insist on Absolute and Unconditional Liability
Holding the guarantor absolutely and unconditionally liable for the debt is also very important.
What this means is that the guarantor promises to pay or perform the obligations of the debtor as soon as the debtor defaults. The result is that the guarantor becomes liable in the first instance with the debtor. This allows the creditor to proceed against both the debtor and the guarantor without having to be required to satisfy the obligations in the first instance against the debtor before proceeding against the guarantor.
Require the Guarantor to Waive Defenses to Enforcement
An essential provision to include in a personal guarantee agreement is one that gets the guarantor to waive some of their legal defenses.
Commercial loan guarantees in Massachusetts often contain provisions where guarantor expressly waives the ability to assert certain rights and defenses to a lender's enforcement efforts. Courts in this state have allowed such waivers to withstand court scrutiny in the belief that any such waiver was a term that was negotiated between sophisticated business entities and, therefore, that it should be enforced according to its plain language.
In many cases, guarantors may attempt to assert defenses and claims belonging to the borrower or principal. In Massachusetts courts, these attempts have gained little traction. The rationale behind this thinking is that the guarantor is not part of the underlying transaction. Therefore, the guarantor cannot later take advantage of any claims and defenses that might arise out of that underlying loan transaction.
Massachusetts Personal Guarantee Lawyers at the Katz Law Group
Personal guarantees in Massachusetts are strictly enforced according to their contractual provisions. Their enforcement is favored as a matter of public policy. However, in order to take advantage of laws favorable to creditors in this state, it is important that you take the time to craft a solid guarantee in order to fully protect your business interests.