A personal guarantee is a legal undertaking by an individual (the guarantor) to repay a loan given to a business if the business itself fails to repay. This commitment is commonly requested by lenders when a business does not have sufficient credit history or assets to secure a loan.
Personal guarantees are governed by state laws, as well as federal regulations in certain cases. For instance, the Uniform Commercial Code (UCC), adopted in some form by most states, contains provisions that affect these guarantees, particularly in Article 9, which deals with secured transactions.
Enforceability of Personal Guarantees
For a personal guarantee to be enforceable, it must meet specific criteria:
- Written Agreement: As per the Statute of Frauds (which varies by state but generally follows principles similar to those found in the UCC § 2-201), a personal guarantee must be in writing and signed by the guarantor. Unless the contract is found to be ambiguous, only the contract itself will count as objective evidence of the meaning of the contract. If the contract is ambiguous, outside evidence could be allowed in to interpret.
- Consideration: There must be a clear exchange of value – the guarantee is often provided in return for the lender extending credit to the business. Important to note though is that the Guarantor does not need to be the party who receives the consideration – the consideration just needs to benefit the party who incurs the debt.
- Capacity and Legality: The guarantor must have the legal capacity to enter into the contract, and the guarantee must be for a legal and valid debt. Drug dealers are likely out of luck in enforcing personal guarantees. There also may be issues of unconscionability, or other reasons in the case law why employees, for example, may not be able to be forced to sign personal guarantees for their employers. Along the same lines, if there was duress or fraud, the personal guarantee could be invalidated by a court.
For businesses, understanding when to request a personal guarantee is crucial. It offers an additional layer of security, especially when dealing with new or financially unstable entities. For individuals, it’s vital to comprehend the extent of the liability. Guarantors are often executives or partners who have a vested interest in the business's success, but they must also be aware of the potential personal financial risk involved.
Personal guarantees play a significant role in business financing, offering security to lenders while posing considerable obligations to guarantors. Both parties should understand the legal implications of these guarantees. Before entering into such agreements, we strongly advise consulting with a legal professional to navigate the complexities of these legal documents.
For tailored legal advice and assistance with personal guarantees, feel free to contact our firm. We specialize in business law and can provide the expert guidance you need to protect your interests.
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