A personal guarantee is a contract wherein an individual agrees to pay a business debt. A business owner will often sign a personal guarantee if a company needs to make a purchase on credit 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.
Personal guarantees are standard in the business world—primarily because opening a business can be a risky endeavor. New business ventures rarely have much in the way of value or assets. Additionally, many businesses fail, leaving creditors with unpaid invoices.
As a result, most creditors won’t agree to extend credit for product or enter into a property lease with a new, unestablished business without requiring more. The supplier or landlord will seek to protect payment of the debt by asking the owner to agree to pay the debt on behalf of the company, if necessary. If the financed amount is significant, a lender might ask an owner of an established business to do the same.
A business owner who consents to the arrangement will sign a contract called a personal guarantee. 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. Filing bankruptcy has the added benefit of wiping out other qualifying debt, as well. If the proprietor doesn’t qualify for a Chapter 7 discharge, Chapter 13 might be a possibility; however, this chapter will require the debtor (bankruptcy filer) to make payments to creditors for three to five years before the balance of a dischargeable debt will get wiped out.
Also, it's important 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 actual signer of the guarantee must file for bankruptcy. For more information, read Are You Personally Liable for Your Business's Debts?
Because business cases can be complicated, the signer of a personal guarantee should seek legal advice from a knowledgeable attorney.