One of the primary reasons small business owners choose to form a limited liability company (LLC) or corporation is to avoid being held personally liable for debts should the business become unable to pay its creditors. But even if you take out a mortgage in the name of the LLC or corporation, you could be liable for a deficiency following a foreclosure. Whether you'll face a deficiency judgment (see below) depends on the circumstances, like if you gave a personal guarantee.
Individuals who create an LLC or corporation generally do it to shield themselves from personal liability. By forming an LLC or corporation, you and your business will be considered separate legal entities. Creditors then aren't able to go after your personal assets to pay business debts—even if the business can't pay them.
Example. Let's say you want to start a property management business that will own and manage a rental property. You want to protect yourself from liability for any business debts, particularly the mortgage loan used to purchase the property. So, you form an LLC and obtain a mortgage in the LLC's name, pledging the assets of the LLC (the rental property) as security for the debt. If you're able to obtain a commercial nonrecourse mortgage loan, the rental property will be the only asset at risk in a foreclosure action.
But an LLC member or shareholder of a corporation could be held personally liable for the debt under certain circumstances.
If you are facing foreclosure or struggling to pay your mortgage, learn about your options in Nolo's The Foreclosure Survival Guide.
Depending on a few factors, the mortgage lender might be able to place the financial liability back into the hands of the business owner personally—even if the mortgage is taken out in the name of an LLC or corporation.
Often, lenders won't finance an LLC or corporation mortgage loan based only on business credit unless that business has an excellent and long-established credit history. Banks are well aware that LLC members and shareholders can't be held personally liable for the LLC or corporation's debts. As a result, many lenders will only extend a mortgage loan to a small LLC or corporation if the business owner gives a personal guarantee.
By signing a personal guarantee, you're volunteering your personal assets as security for the debt if the business can't repay the loan. In the event that the mortgage is foreclosed, you can be held personally liable for the loan. The lender can then come after you for a deficiency judgment, as long as state law doesn't prohibit it.
What is a deficiency judgment? When a lender forecloses, the borrower's total debt sometimes exceeds the foreclosure sale price. The difference between the sale price (or the property's fair market value) and the total debt is called a "deficiency."
Example. Say the total debt owed is $400,000, but the property sells for $350,000 at the foreclosure sale. The deficiency is $50,000.
A "deficiency judgment" is a personal judgment that the lender obtains against the borrower to recover the deficiency. Generally, once the lender gets a deficiency judgment, it may collect this amount—in our example, $50,000—from the borrower using collection methods such as garnishing wages or levying a bank account.
Whether your lender can go to court and get a judgment for the deficiency, and then collect it, depends on state law. Certain states prohibit deficiency judgments under particular circumstances.
Another way that you might potentially open yourself up to personal liability is by signing the mortgage documents, such as the promissory note, in your own name instead of the name of the LLC or corporation. By signing your own name, rather than on behalf of the LLC or corporation in your capacity as an owner or officer, you could be held personally liable for the debt.
When signing any mortgage loan documents, be sure to carefully read the contract to determine if it obligates you personally in addition to the LLC or corporation. If you have any questions about personal liability regarding a mortgage transaction or if you are facing foreclosure of a property mortgaged by an LLC or corporation, you should speak to a qualified attorney who can advise you about what to do in your particular situation.