As your business grows, you're probably going to see a lot of different contracts. There's one provision you need to watch out for though, and that is a personal guarantee.

You may not have run across a personal guarantee yet, but they have become more and more common. Many people aren't sure why they're even in the contract. But I can tell you from experience with a lot of clients that the personal guarantee can be the one thing that really comes back to bite you. You may not have thought about it when you signed that contract, but then a couple of years later, you find yourself in court and you're personally on the hook for business debt.

What is a Personal Guarantee?

A personal guarantee is essentially a promise by you that you will pay the debt of the company if the company is unable to. So if the company is unable to pay something, let's say your office rent, then the landlord can sue you individually as well as the company for payment of the rent.

Who Signs a Personal Guarantee?

Who signs a personal guarantee in your business depends on ownership. Usually, if you own more than 20% of the business, you would be asked to sign the personal guarantee. However, you don't have to sign it, but usually, a bank will ask for 20% or more owners to be signing off on personal guarantees. Now if you're working at a business and you're not a 20% or more owner, and somebody asks you to sign a personal guarantee, I would wait a second. I would check the documents and talk to a lawyer before you sign them. If you're under 20% ownership, you really might not need to sign that personal guarantee.

The Effects of a Personal Guarantee

What I found with personal guarantees is that many of my clients never read them. They're coming to me because now they've been sued. Or even worse, a creditor just took a judgment against them without a lawsuit because they had signed a personal guarantee that allowed them to do that.

Things to look for in the personal guarantee are provisions that, for example, agreed to out-of-state court procedures. What if you live in Kentucky and you're agreeing to a New York City Court for your personal guarantee? Are you going to want to go back and forth to New York City to defend against the lawsuit? Another provision that's very common that's concerning to me is a waiver of service of documents. This provision says that if you fail to make a payment, they don't even serve you with the documents or they just drop it in the mail to you at some point at which they may already have a judgment against you before you see the document.

Speaking of judgments, one of the most concerning provisions you'll also see is one that says if you fail to make a payment, they can just file a judgment against you. You don't even get served with papers. You don't have time to contest it. You don't have time to make the payment a day or two late they just take a judgment against you.

So personal guarantees are a very powerful tool that can be used against you. Before you sign that personal guarantee, make sure you read the entire contract. A lot of times what I've seen is a small business owner signing on behalf of the business, not realizing that the next page has them signing one more time and that one more time is the personal guarantee. Now they're on the hook if their business is sued.

If you're given a personal guarantee, you don't have to sign it on the spot. Take your time, speak to a professional, talk to your attorney. Talk to somebody else. Make sure you understand what's in that document and what you're signing. Before you sign off on a personal guarantee, let's set up a Legal Strategy Session to see if it's the best option for your business. We can review the personal guarantee and make sure you understand what you're signing. Never, ever, sign a personal guarantee without understanding what you're signing.

Andrew Ayers
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I work with business and estate planning clients to craft legal solutions to protect their legacies.