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Personal Guaranties – What Happens if the Borrower Defaults?

By: Chad Nelson

Due to the tough economic conditions created by the COVID-19 pandemic, many businesses, both large and small, are facing unprecedented financial challenges. As financial relief programs such as the Paycheck Protection Program dwindle, borrowing via traditional business lending arrangements will continue to rise, and loan performance will progressively weaken as a result of the harsh and lasting impacts from COVID-19. As you assess the financial stability and future of your business, consider the impact of a key feature of many loans:  personal guaranty agreements.

A personal guaranty obligates an individual, oftentimes an officer or director of a company, to be responsible in his or her individual capacity for repayment of a company debt in the event of default. In Texas, this personal obligation is separate from the primary obligor’s promise to pay,[1] meaning that the creditor could seek payment directly from the guarantor even before pursuing payment from the borrower.

Personal guaranties are found frequently in business loans, lines of credit, property loans, and more. These guaranties often appear to be standard, “boilerplate” language in a credit application or other loan document; but, their implications should not be overlooked. Here are a few things to know about guaranty agreements under Texas law:

(1) What are the essential terms of a guaranty agreement?

A guaranty agreement consists of (i) the parties involved (i.e., the creditor, borrower, and guarantor), (ii) a manifestation of intent to guarantee the obligation, and (iii) a description of the obligation being guaranteed.[2]

(2) Is the guaranty agreement enforceable?

For a personal guaranty agreement to be enforceable, the creditor must show: (i) the existence and ownership of a guaranty contract, in writing, (ii) the terms of the underlying contract (e.g., the loan agreement with the borrower), (iii) the occurrence of the conditions upon which liability is based (e.g., default by the borrower), and (iv) the failure or refusal to perform the promise by the guarantor.[3]

(3) Are there any defenses to payment?

In addition to universal contractual defenses such as waiver, ratification, statute of limitations, indefinite terms, etc., a guarantor also may assert defenses to the guaranteed obligation that the primary obligor could have asserted.[4] The available defenses vary on a case-by-case basis, depending on the express terms in the loan documents and facts unique to a particular situation.

(4) If the guarantor is forced to pay, does he have any recourse against the borrower?

Yes, a guarantor may have recourse against the borrower to the extent he or she has satisfied the debt obligations. First, the guarantor should look to the express terms in the loan documents and the operating agreement (if he or she is an officer or director of the borrowing entity), which may establish terms for indemnification and/or reimbursement by the company. Second, even if the documents are silent as to a guarantor’s right to recovery against the borrower, courts may permit enforcement of an implied obligation on the borrower resulting from the guarantor’s repayment of debt on its behalf.[5]

“Risk comes from not knowing what you’re doing.” – Warren Buffett. Therefore, whether you already have executed a personal guaranty or are contemplating doing so, due diligence will help you better understand your personal risk exposure and help to navigate the often tumultuous waters of a guarantor-borrower relationship.  

 



[1] See, e.g., Wasserberg v. Flooring Servs. of Tex., LLC, 376 S.W.3d 202, 205 (Tex.App.—Houston [14th Dist.] 2012, no pet.).

[2] See Material Partnerships, Inc. v. Ventura, 102 S.W.3d 252, 261 (Tex.App.—Houston [14th Dist.] 2003, pet. denied).

[3] Id.

[4] Wiman Tomaszewicz, 877 S.W.2d 1, 6 (Tex. App.—Dallas 1994, no writ) (citing Mayfield v. Hicks, 575 S.W.2d 571, 574 (Tex.App.1978) (noting the “general rule that guarantors have the right to raise any defenses to the guaranteed obligation that the principal may have”); Stephens v. First Bank of & Trust of Richardson, 540 S.W.2d 572, 574 (Tex.App.1976) (“A surety or guarantor can assert any defense to a suit on a note available to the principal.”)); see also First Gibralter Bank v. Bradley, 98 F.3d 1338, at *6 (5th Cir.1996) (unpublished) (citing this general rule and stating that the defendants “do have standing as guarantors of the loans to assert the defenses that would have been available to the borrowers”).

[5] E.g., Northwest Otolaryngology Associates v. Mobilease, Inc., 786 S.W.2d 399, 402 (Tex. App.—Texarkana 1990, writ denied) (“In the present case, Mobilease discharged its obligation under its liability as the guarantor and was entitled to pursue its action for reimbursement against Northwest as the principal obligor.”).

 


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