Personal Guarantees: How to Limit Your Exposure
Limiting your exposure to potential liability is important for every businessperson. This often includes forming a corporation or limited liability company, so that the business entity is completely separate from your personal assets (like your home). However, it is not uncommon to be asked to provide a personal guarantee for various business obligations, the most common being related to guaranteeing a commercial lease, a line of credit, or a loan where the company is either a corporation or a limited liability company (LLC). This places the business owner in an uncomfortable position. In order to conduct business, the owner may be required to personally guarantee a long-term contractual obligation. In other words, if something happens to the business, the owner (or guarantor) will be personally responsible for the obligations of the business.
In most cases it may be unavoidable and from the perspective of the business or landlord, it is important to have a personal guarantee in case the corporation or LLC goes belly-up either without paying or before the end of the lease term. There are, however, some things that can be done to reduce your personal exposure to the guarantee.
- Limit the Amount of Time for the Guarantee. It is important to limit the amount of time that the personal guarantee is effective. This will inform you of a definite date where you will no longer be personally liable for the obligations of the company. For example, if the lease is for a five-year period, try to limit the personal guarantee to the first two years.
- Limit the Guarantee to a Single Term. If the lease or other contractual obligation includes options to renew, be sure to limit the personal guarantee to the first term only. In the alternative, require that a new guarantee is necessary for any modifications or extensions of the contract term.
- Add Additional Guarantors. If possible, spreading the potential liability among partners/investors in the business is a good way to reduce your potential liability.
- Cap Liability. Negotiate a liability limit for the contractual obligation. For example, on a five year commercial lease, cap the total damages at an amount equaling six months of rent.
There are various laws that apply to personal guarantees which are important to understand in every transaction. Obtaining legal advice before you enter into a personal guarantee is critical to understanding your rights and responsibilities. The attorneys at Vogt, Resnick & Sherak, LLP have experience with negotiating and litigating personal guarantees and can assist you in understanding these sometimes complex contractual devices.