In commercial lending, obtaining a personal guaranty or corporate guaranty falls under the routine everyday standard best practices of any lender.
The need and usefulness of the guaranty often becomes more evident when lenders take on the risks involved with helping small businesses and start-ups that have inadequate revenues and/or inadequate collateral to provide as security for conventional and/or government back loans. I ideal guaranty is unlimited and unconditional. A guaranty provides a lender with a source of repayment in case the borrower defaults on repayment or otherwise fails to perform under the loan agreement. The guaranties can be either unlimited or limited, and can be conditional or unconditional (absolute). Let us examine the unlimited and unconditional guaranty and how small business lenders can maximize their ability to collect on defaulted loan agreements.
What is an Unlimited Guaranty and Why it is Important to Business Financing?
An “unlimited guaranty” will make the guarantor liable for any debt owed now, or arising later, between the lender and borrower. A guarantor’s exposure to liability can be restricted to a specific debt, or a specific dollar amount, owed by the borrower which creates a “limited guaranty”.
Whether a guaranty is limited or unlimited, for enforcement purposes, the guaranty will be construed under the same conditions of any other contract and require careful attention paid to the explicit terms of the guarantor’s obligations. Courts generally construe guaranties in the most favorable light of a guarantor when there is dispute with a lender, and this is even more so when the guarantor is an individual and not a business entity. A guaranty will be strictly construed based on the terms in the agreement which presumably should be narrow in scope and reflect the intention of the parties. See McGinley Partners, Ltd. liability Co. v. Royalty Properties, Ltd. liability Co., 2018 IL App (1st) 171317 at P52citations omitted.
The terms of a guaranty also should be free of legal jargon especially when the guarantor is an individual versus a corporate guarantor. The terms of a guaranty should explicitly outline the duties of the lender and borrower, and the obligations of the guarantor. The duties of the lender and borrower usually consist of conditions precedent that need to occur prior to requiring payment from the guarantor. The most obvious conditions precedent are default by the borrower and the lender providing a written notice of default to the guarantor. Another condition precedent may require the lender to make or exhaust collection efforts against the borrower before seeking payment from the guarantor.
What is an Unconditional Guaranty and Why it is Important Business Financing?
The prerequisite of a lender attempting to collect from a borrower before collecting from a guarantor creates a “conditional guaranty” or a “guaranty of collectability”. A “conditional guaranty” greatly benefits a guarantor by potentially requiring a lender to file a lawsuit against a borrower or ultimately a lender needing to liquidate the assets of the borrower. The requirement of the lender to collect against the borrower first may significantly reduce the amount owed by a guarantor. While the “conditional guaranty” benefits the guarantor, a lender will suffer the consequences by not being able to immediately seek payment from the guarantor.
A lender may seek immediate payment from a guarantor when there is a “guaranty of payment”. The “guaranty of payment” allows a lender to pursue collection efforts against the guarantor without needing to first seek payment from the borrower. The parties also can agree to have a “guaranty of performance” that allows the lender to look to the guarantor to complete other obligations of the borrower such has supplying goods and/or services.
Key Takeaway for Lenders for Unlimited and Conditional Guaranty
A lender should seek to have clear language in an agreement that establishes the immediate obligation of payment and/or performance by the guarantor if the borrower defaults under the loan agreement. The immediate obligation for payment or performance also should not be limited to any specific amount and/or any specific debt owed by the borrower. It is crucial that lenders make certain that their guaranty agreements fully and clearly explain that the guarantor is signing an “unlimited guaranty of payment” or an “unlimited guaranty of performance”, to alleviate any ambiguity as to what is expected from the guarantor, thereby requiring a court to resolve any dispute in favor of the lender.
McKenna Storer attorneys have deep expertise in supporting small business lenders with government guaranteed and conventional loan products. Contact Jaime Dowel with questions about unlimited and unconditional guaranty or other small business loan matters.