Personal Guarantee Mania

Most if not all of us have had to sign a personal guarantee. A bank or other credit lender to further facilitate and securitize a loan usually requests this. It generally means that if the loan is in default the creditor may seek further restitution by filing a legal action against the guarantor personally for the defaulted loan. In most cases the lender may file a default against the secured property or the individual guarantor, or both. A personal guarantee is generally the last defense a lender has to make sure they recover their loan funds. They mindlessly ask for it and generally get it.

Can you structure a guarantee so that the individual guarantee is less than 100% of the loan amount? Certainly? Say for instance that a lender places a $500,000 loan on a $750,000 income producing property and asks for a 100% personal guarantee from the borrower. The borrower may balk, telling the lender that the income on the new property carries a 1.4DCR, there is no deferred maintenance, and the property is full and located well. Does the lender really need a 100% guarantee? Probably not. Here is the mindless stage of our Lender friends. They ask without thinking about the need for a full guarantee. Why not counter with a “partial guarantee” of say 25% of the loan amount. Is the lender still secure? Yes! He also has a $125,000 individual guarantee to offset any loan default on the $750,000 property. In total he has $875,000 in collateral for a $500,000 loan. This is a 57% loan to value ratio. See, your personal guarantee is a perk to the loan. An add on with value. In this case a $125,000 extra.

Personal guarantees can be applicable to “carve-outs” as well. This means that certain aspects of the loan are legally bound by the borrowers guarantee. For instance, environmental may be a personally liable issue, malfeasance, neglect, embezzlement, but not the loan per se. Most of the conduit loans have these types of provisions. They generally “carve out ” relevant issues and make the borrowers liable only for them. No reason you can’t ask you lender about these issues as well.

Most Real Estate practitioners are able to avoid personal guarantees in large part by purchasing properties with individual seller carry back financing. The hard money lenders are the source of most “personal guarantees”.

Language can be important as well. The words “this is a guarantee of collection and not of payment” puts the lender on notice that the Lender is obligated to go through foreclosure first (perhaps a long process) before ever declaring or stipulating how much must be paid by the guarantor. This would be termed the “deficiency amount”. For instance a property loan you have guaranteed is being foreclosed upon in the amount of $500,000. The lender takes four months to foreclose and sells the property on the courthouse steps for $450,000 and then sues under the guarantee for the remaining $50,000.00. It is important to note that foreclosure lays are different in each state, but in general the lender forecloses and then seeks restitution for any deficiency.

Another way to eliminate a guarantee is to work your way out of it. Say your property is only 35% occupied. The lender may (perhaps rightfully) request a 100% personal guarantee. But, if you stabilize the property through diligent efforts for six (6) months at 60% occupancy your personal guarantee is automatically reduced to a 50% guarantee. If you achieve more occupancy your personal guarantee keeps diminishing.

Remember when you personally guarantee a loan you are sanctifying the entire loan documents created by your lender. It is serious business and one, which many of my good commercial friends have been victim to for not paying homage.

In summation:

  1. A “Personal Guarantee” is worth a lot of money. That’s why lenders seek them. Be on guard. Don’t be cavalier by giving it out carte blanche.
    Observe and study the guarantee language.
  2. Try to negotiate lesser guarantee percentages. Avoid the 100% guarantee. Ask yourself if the required guarantee is overkill?
  3. Take your time. This is usually a substantial amount of money we are talking here.
  4. If you ever need a heart transplant ask a lender for his cuz it has never been used. You may think that lender is your friend, and he or she may be, but it is a strangely adversarial relationship when things start going haywire. The documents prevail.
  5. Somehow make arrangements upfront to work your way out of the personal guarantee.

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