A personal guarantee is a contract wherein an individual agrees to pay the debt of another. A business owner will often sign a personal guarantee if a company needs to make a credit purchase for things such as real estate, inventory, supplies, or services. By signing the agreement, the owner commits to paying the debt with personal (nonbusiness) funds if the company can't satisfy the obligation.
Also, suppose you ask a friend or relative to be a "cosigner" to help you qualify for a personal loan. If they agree, they will be responsible for the debt if you fail to pay. Although "personal guarantee" isn't commonly used to describe consumer cosigner transactions, we also explain the responsibilities of cosigners and how to eliminate a cosigner's responsibility in bankruptcy.
Personal guarantees are standard in business, primarily because opening a business can be risky. New business ventures rarely have much in the way of value or assets. Additionally, many companies fail, leaving creditors with unpaid invoices.
As a result, most creditors won't agree to extend credit for a product or enter into a property lease with a new, unestablished business without requiring more or if the financed amount is significant. The supplier or landlord will seek to protect the payment of the debt by asking the owner to agree to be personally responsible for paying the debt on behalf of the company, if necessary.
A business owner who consents to the arrangement will sign a personal guarantee contract. Once the personal guarantee is in place, the creditor can seek payment from the business owner's personal assets if the business fails.
When a company goes under, it's common for someone who has signed a personal guarantee to wonder if there's a way to get out of it. However, unless the lender agrees to waive it (which would be unlikely) or some fundamental flaw exists in the agreement, the personal guarantee will remain binding.
In many cases, a business owner can file a consumer bankruptcy to discharge (wipe out) the personal guarantee. For clarity, a "consumer bankruptcy" means the business owner must file bankruptcy personally, not put the business in bankruptcy, to erase the personal guarantee. However, the bankruptcy filing has the added benefit of allowing the business owner to wipe out other qualifying personal debt.
Most bankruptcy filers prefer to file for Chapter 7 bankruptcy because it erases qualifying debt quickly, often within four months. If the proprietor doesn't qualify for a Chapter 7 discharge, Chapter 13 might be possible. However, this chapter will require the bankruptcy filer to pay creditors for three to five years before the balance of a dischargeable debt will be eliminated or "discharged."
Example. Suppose you took a business loan to pursue your lifelong dream of opening a cupcake bakery. Because your business was new, the bank asked you to execute a personal guarantee. By signing the guarantee, you agreed to use your personal assets to pay off the loan if the business couldn't do so. If the cupcake business dried up and the bakery closed, you'd likely be able to wipe out the guarantee by filing an individual Chapter 7 or Chapter 13 bankruptcy.
Again, it's essential to understand that filing a Chapter 7 bankruptcy on behalf of the business will not get rid of a personal guarantee. To wipe out the debt, the signer of the guarantee must file for bankruptcy.
For more information, read Are You Personally Liable for Your Business Debts? Also, learn more about when you'd put a business in bankruptcy instead of filing yourself in Chapter 7 vs. Chapter 13 for Small Business Owners.
It's also common for individuals not to have sufficient income or a high enough credit score to qualify for large credit purchases. Cosigners are often needed when a borrower doesn't meet a lender's requirements when purchasing a car, computer, or other large purchase.
In this situation, the borrower can ask someone to guarantee payment to improve the odds of getting a loan. A guarantor is an individual or company that pays an obligation if the borrower fails to do so. These transactions are typically referred to as "cosigned" loans.
When the borrower misses a payment, the lender has the right to ask the guarantor to take up the payments or to pay off the loan. At that point, the guarantor is subject to the same collection activities under state law: telephone calls, letter demands, lawsuits, and even garnishment and property seizures.
The bank can pursue the borrower and the cosigner until the loan is paid in full (or the borrower and cosigner discharge the debt in bankruptcy). Also, if the guarantor pays the debt, the guarantor can seek reimbursement from the borrower if the borrower hasn't eliminated the responsibility to pay in bankruptcy.
Just about any willing person can agree to guarantee a loan taken out by someone else. When the borrower is an individual, and the money is for personal or educational purposes, the guarantor is usually a parent, another relative, or a good friend.
In many cases, yes. In fact, it's a common reason that people file for bankruptcy. But bankruptcy isn't an option in all cases. For example, a guarantee for an educational loan won't go away unless you can show undue hardship.
Because business cases can be complicated, the signer of a personal guarantee should seek legal advice from a knowledgeable attorney.
Did you know Nolo has made the law easy for over fifty years? It's true, and we want to ensure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!
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