Timothy Hassett

There is nothing more personal than a personal guaranty.

Business owners often go to great lengths to minimize the risk of personal liability. At a minimum, a prudent business owner will operate his or her business under the protection of a corporation, limited liability company or other form of business entity, buy liability insurance to protect against liability and take steps in the operation of the business to reduce exposure to personal liability.

But, when it comes to borrowing money or obtaining credit, it is often difficult, if not impossible, to avoid going “personal”.

Most of us, if put in our lender’s shoes, would want the same thing. Our lender wants to make sure we have every incentive to repay the loan, including (and maybe most importantly) the risk of personal liability. A lender’s hook into the personal assets of the business borrower is an important part of the deal for the lender and, even in good times, it can be difficult to avoid signing a personal guaranty. Once the guaranty is signed, life is never quite the same again. Being personally liable for a business debt brings cold hearted reality to every business dream.

So, with little chance of avoiding a personal guaranty, are there any strategies for reducing their reach? The answer is yes, but it requires some forethought and planning.

Before we go there, however, there is a bit of comforting information for those business owners who have signed a personal guaranty and own a homestead in joint tenancy with a spouse.

In 2004, the Minnesota Supreme Court decided the case of Kipp v. Sweno. The case involved homeowners who obtain a personal judgment against the builder who built their home. After obtaining the judgment, the homeowners sought to foreclose on the builder’s home. The builder was married and owned his homestead in joint tenancy with his spouse.

There is a law in Minnesota which protects the homestead against the claims of creditors but only up to $300,000.00 in equity ($750,000.00 if the homestead is used primarily for agricultural purposes). In this case, the creditors claimed that the equity in the builder’s homestead exceeded the limit. (At the time this case was decided, the limit was $200,000.) The court ordered the sale of the homestead and the builder appealed. The case raised a number of legal issues, but the issue which carried the day dealt with the fact that the builder owned his homestead in joint tenancy with his spouse. The central question of the case was whether, with a judgment against only the builder, could the creditors foreclose against the couple’s homestead and eliminate the interest of the builder’s spouse in the homestead?

The Supreme Court said no. The Court carefully analyzed the longstanding policy in Minnesota to protect the homestead and noted that, by allowing this personal judgment to be foreclosed, the joint tenancy between the builder and his spouse would be severed and she would lose her interest in the home even though she was not liable for the debt.

The holding in Kipp v. Sweno protects the homestead
owned by spouses in joint tenancy from creditors
with a judgment against only one of the joint tenants.

After this case was decided, the legislature expanded the homestead protection by enacting a statute which requires, among other things, that the creditor obtain a court order before attempting to force the sale of the homestead. The court, not the creditor, determines whether or not the owner’s equity exceeds the $300,000 ($750,000 for agricultural homesteads) statutory limit. In addition, the statute extends protections not only to non-debtor joint tenants but also to non-debtor life tenants and non-debtors who have the right to inherit the homestead under state statute.

There are also a few things a business owner can do to limit the reach of a personal guaranty. Here are some ideas:

1. Have More Than One Option
   When looking to borrow, have more than one option. Some banks and other financial institutions, and some trade creditors, may be willing to limit the reach of a personal guaranty when competing for your business.
   
   
2. Limit the Exposure/Business Partners
   You may want to ask the lender to limit your exposure under a personal guaranty to your percentage interest in the company. So, for example, if you have three partners and you each own 33.33% interest in the company, ask your lender to limit your liability under a personal guaranty to one-third of any claimed amount. Some lenders will accommodate such a request.
   
   
3. Spouse as Business Partner
   Consider whether you want to include your spouse as a co-owner of your business. Banks and other lenders typically want all those with an ownership interest in the business to sign a personal guaranty when the business takes out a loan. (Some banks will waive the personal guaranty requirement if the business partner owns 20% or less in the company.) While there are many factors to consider, limiting a spouse’s exposure to business debts is an important goal. In the Kipp v. Sweno case, if both husband and wife were liable, the homestead would have been lost.
   
   
4. Limit the Length of the Personal Guaranty
   If you will be reducing the amount of the loan over time, you may want to ask your lender to consider limiting the personal guaranty to the first two or three years of the loan with the thought that your real estate or other assets which secure the loan will, at that point, provide adequate protection for repayment to the lender.
   
   
5. Avoid Self Renewing or Blanket Personal Guarantees
   Often, when working with suppliers, a business owner may sign a personal guaranty at the start of the relationship without realizing that this personal guaranty will continue indefinitely or renew automatically. I recently reviewed a 12 year old guaranty which a trade creditor was asserting as a basis for personal liability. You may want to put a sunset date on a personal guaranty or negotiate with the trade creditor to eliminate or limit the reach of the personal guaranty after you have established yourself as a reliable borrower.

Personal guarantees are a reality few business owners can avoid. However, if presented with a guaranty, attempt to limit its scope and impact by requesting reasonable limitations.

For additional information, please contact Timothy Hassett (651-312-6006).