The Personal Guarantee: The Clause That Can Put a Business Owner’s Own Assets at Risk

One of the main reasons business owners form an LLC or corporation is to create separation between their business and personal finances.

Then they sign a lease, take out a business loan, open a line of credit, or enter into an agreement with a vendor.

Buried somewhere in the paperwork may be two words that can significantly change the amount of personal risk involved: personal guarantee.

A personal guarantee can make a business owner personally responsible for certain obligations of the company. That means if the business cannot pay what it owes, the other party may be able to pursue the individual who signed the guarantee, depending on the agreement and circumstances.

For New York business owners, understanding a personal guarantee before signing one can be just as important as negotiating the rest of the contract.

What Is a Personal Guarantee?

A personal guarantee is a contractual promise by an individual to be responsible for an obligation owed by another party, usually a business.

Consider a common example.

You own an LLC and want to lease commercial space. The LLC is listed as the tenant. However, the landlord also requires you, as the owner, to personally guarantee the company’s obligations under the lease.

If the business later stops paying rent, the fact that the lease is in the LLC’s name may not necessarily end the matter. The landlord may look to the guarantee and attempt to hold you personally responsible for amounts covered by it.

Personal guarantees may appear in many types of business transactions, including:

• Commercial leases
• Business loans
• Lines of credit
• Equipment financing
• Vendor and supplier agreements
• Certain franchise agreements
• Other business contracts involving credit or ongoing financial obligations

The exact effect of a guarantee depends on its language. That is one reason it should never be treated as just another signature page.

Doesn’t Having an LLC Protect My Personal Assets?

An LLC can provide important liability protection, but that does not mean a business owner can never become personally responsible for a company obligation.

A personal guarantee is different because the owner is voluntarily agreeing to take on a personal contractual obligation.

In other words, there is an important difference between:

The company owes the money.

and

The company owes the money, and I have also agreed to be personally responsible under certain circumstances.

That distinction can become extremely important if the business experiences financial problems.

The Most Important Question Is Not Just Whether There Is a Guarantee

Business owners sometimes focus on whether a contract contains a personal guarantee at all.

An equally important question is:

What exactly does the guarantee cover?

Not every personal guarantee is written the same way.

One agreement might expose the guarantor to a broad range of obligations. Another may contain limitations based on time, amount, or particular circumstances. Some guarantees may continue through renewals or modifications, depending on their terms.

The details matter.

For example, a business owner reviewing a guarantee should understand questions such as:

• Is there a maximum amount the owner can be required to pay?
• Does the guarantee cover only unpaid rent or other amounts as well?
• How long does the guarantee remain effective?
• Does it continue if the underlying agreement is renewed or modified?
• Are attorneys’ fees or collection costs included?
• Are there conditions that can limit or end the guarantee?
• What happens if the business closes or leaves the property early?

A few paragraphs in a lengthy contract can potentially create substantial personal exposure.

Commercial Leases Deserve Particular Attention

Personal guarantees frequently become an important issue when negotiating commercial leases.

A landlord may be reluctant to rely entirely on a newly formed company with limited assets or operating history. As a result, the landlord may request a guarantee from one or more owners.

From the landlord’s perspective, this provides additional security.

From the business owner’s perspective, it creates another layer of risk.

Imagine a business signs a multi-year lease and, two years later, sales decline significantly. The owner decides the business can no longer afford the location and closes.

The company’s obligations under the lease do not necessarily disappear simply because the doors are closed.

If the owner signed a personal guarantee, the language of that guarantee may become extremely important in determining what happens next.

Can You Negotiate a Personal Guarantee?

Business owners should not automatically assume that every provision presented to them is nonnegotiable.

Depending on the transaction and the willingness of the other party, it may be possible to negotiate the terms of a personal guarantee.

For example, negotiations might involve limiting the amount covered by the guarantee, reducing the guarantee after the business has performed successfully for a certain period, or establishing conditions under which the owner’s personal obligations end.

Whether those options are available depends on the transaction, the parties’ bargaining positions, and the language of the agreement.

The important point is simple: ask before you sign.

It is much easier to discuss the scope of a guarantee while a contract is still being negotiated than after a dispute has already developed.

What If You Already Signed One?

Finding a personal guarantee in a contract you already signed does not necessarily tell you, by itself, what you may ultimately owe.

The entire agreement should be reviewed.

The language of the guarantee, the underlying obligation, any amendments to the contract, the parties’ conduct, and the particular circumstances of the dispute may all be relevant.

This becomes especially important if you receive a demand for payment personally after your business defaults on an agreement.

Ignoring the demand may limit your options. At the same time, immediately assuming that you are responsible for everything being demanded may also be a mistake.

Understanding what you actually agreed to should come first.

Read the Contract as Both a Business Owner and an Individual

When signing a business agreement, it is easy to focus on the numbers that affect the company: monthly rent, interest rates, payment deadlines, deposits, and contract length.

A personal guarantee requires you to look at the agreement differently.

You are no longer evaluating only what the deal could mean for the business. You also need to consider what it could mean for you personally if the business relationship does not go according to plan.

That does not mean every personal guarantee should automatically be rejected. In some transactions, a guarantee may be part of getting the deal done.

But it should be an informed business decision, not a surprise discovered after the company runs into trouble.

Know What You Are Putting on the Line Before You Sign

A personal guarantee may occupy only a small section of a contract, but its consequences can extend well beyond the business itself. Before signing a commercial lease, loan agreement, vendor contract, or other business agreement containing a personal guarantee, make sure you understand what you are agreeing to and whether there may be terms worth negotiating.

At MontanaroLaw, we help New York business owners review, draft, and negotiate contracts with an eye toward both the immediate deal and the risks that may arise later. If you have been asked to sign a personal guarantee, or you already signed one and a dispute has developed, contact MontanaroLaw today to schedule a consultation. We can review the agreement, explain the obligations it may create, and help you determine the best way to protect your business and your interests.