28 May Beware the Personal Guaranty
When operating a small business, it is easy to forget about the formalities of maintaining the facade of a business entity. Whether your business is a corporation or a limited liability company, the structure of the business is to protect the owners of the business against the debts of the business. Think of the business as another person entirely separate from yourself. You are no more liable for your next door enighbor’s debts as you would be for your company’s bills.
However, when running a small business, most creditors are unwilling to accept only the company’s promise to pay the bill. Many times, the creditor will insist that the owners or operators of the business also accept liability for the debt. This is called a personal guaranty. in general terms, a guaranty requires that the person who is primarily responsible for the debt fails to pay. Then the guaranty kicks in and the guarantor can be required to pay. This is different from a co-maker who is always equally responsible for the payments with the borrower on the debt.
As a business entity gains in age and experience showing itself responsible to pay its bills, a creditor is less likely to require personal guaranties. However, even an established business can fall on hard times. When that happens, personal guaranties are not uncommon. When that business ultimately fails, the guarantors could be on the hook for the business debts.
Recently, the owner of an oil company in business for nearly 70 years was forced to file Chapter 7 bankruptcy because he signed personal guaranties for his business. While the company may have been mis-managed by his employees, he will bear the brunt of the responsibility for the failure of the business. And that may cost him everything he and his family worked for over the last 70 years.
The moral of this story is to make sure that you always maintain your corporation or LLC in good standing, run it like the business that it is, and avoid signing any personal guarantees.