It may come as a surprise to some, but not all personal guaranties are created equal. Most lenders require an affiliate or principal of the borrower to sign a personal guaranty of the loan. These guaranties are most often “full recourse,” which requires the guarantor to pay back the loan if the borrower does not.
Many would-be guarantors can be hesitant to sign a guaranty when they have significant or special assets they wish to protect; they may shy away from such an obligation, cause issues in negotiation, or otherwise frustrate or delay a closing. One way to lessen their concerns is to offer slightly less extensive guaranties – either a Limited (aka “Bad Boy”) Guaranty or a Springing Guaranty.
This article will explore the differences between these guaranty types, as well as other features that all guaranties share.
Full Recourse Guaranty
A full recourse guaranty operates exactly as it sounds. It creates a separate obligation for the guarantor to ensure all of the borrower’s obligations are fulfilled. This extends beyond just the monthly payment but all of the other promises and covenants the borrower has made throughout the loan documents. The guarantor’s liability in a full recourse guaranty is total and unconditional.
Limited Guaranty
A limited guaranty, often referred to as a “bad boy” guaranty, is one that, for the most part, causes the guarantor to be liable to the lender only if the borrower, the guarantor, or one of their affiliates does one or more of the listed bad acts. A partial list of these includes fraud, waste of the property, failure to pay taxes, failure to maintain insurance, failure to comply with representations and warranties, and gross negligence or criminal acts. The liability of the guarantor in these situations is further limited to only the costs, expenses, and liabilities that the lender incurs as a result of these acts.
The limited guaranty will, however, cause the guarantor to still be liable on the full loan in the event of a few other occurrences, such as a bankruptcy filing, a sale or transfer of the property without permission or payoff (including a junior lien), if the borrower takes out any other loan, or the borrower pledges its ownership or membership interests.
Springing Guaranty
A springing guaranty is one that ensures that the guarantor has no liability to the lender unless one or more bad acts takes place, at which point the guaranty provisions “spring” into effect and the guaranty becomes essentially full recourse. The same or similar bad-acts described above in the limited guaranty apply. This form of guaranty is a sort-of hybrid approach between full recourse and limited.
Neither the limited guaranty nor the springing guaranty creates liability for the guarantor as a consequence of the borrower’s simple default on payment. Only certain bad acts can trigger liability. Though these acts cover a wide range of potential occurrences, simply failing to pay the loan, whether due to negligence or just bad luck will not trigger these types of guaranties.
Guaranty of Completion / Construction Guaranty
With the full recourse version of the guaranty, if a “Standard” or “Extensive” construction reserve is selected, then the guaranty will also contain a Completion Guaranty section. This extra section adds specific language to ensure that the guarantor is equally responsible for completing the construction on the property to the same extent as the borrower.
If you wish to have a third party (someone other than the existing guarantor) guaranty for the completion of construction, as opposed to the other obligations under the loan, you may select a third-party construction guaranty. This type of guaranty limits the construction guarantor’s obligations to only the completion of the construction project, except, however, that if they should fail to complete the construction project, their obligations are automatically expanded to cover all of the borrower’s obligations, including loan payments. You may combine this version of guaranty with the other versions as a separate stand-alone document.
Spousal Consent
A guaranty will automatically include a signature line for the spouse of the guarantor to sign and acknowledge the guaranty in the following states: Alaska, Arizona, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. A spouse’s consent is not absolutely required, but it is strongly recommended.
These states follow what is known as a “community property” rule. This means that property or assets acquired during the marriage are jointly owned by both spouses. As a result, if one spouse were to make a personal guaranty on a loan, the lender could only go after the guarantor’s individual assets, and not any assets jointly owned by both spouses. If the non-guarantor spouse signs the consent, however, the lender could go after the guarantor’s individual assets and the jointly owned assets. The following table outlines this clearly:
Community Property Asset Categories:
- Guarantor’s individual assets
- Guarantor’s and their Spouse’s joint assets
- Spouse’s individual assets
Without a spousal consent, the lender can only go after #1. With a spousal consent, the lender can go after both #1 and #2. When a guarantor is married, it is typical that the majority of assets are owned jointly by both spouses. For this reason, it is strongly recommended that lenders obtain the guarantor’s spouse’s consent.
You may have noticed that California is not on the list of states shown above, even though it is a “community property” state. California law specifically exempts spouses from having to sign a consent form for the community property to be subject to collection under the guaranty.
Waivers
Each guaranty contains a series of waivers that the guarantor agrees to. These waivers provide the lender with as much flexibility as possible in the way it may go after the assets. In some states where it is possible, a lender may wish to go after the guarantor’s assets before the borrower’s or the property itself. Without these waivers, such a course of action may be prohibited. Several other waivers include, but are not limited to, waiver of notice of renewal, extension, or modification of the underlying loan; waiver of defenses related to lender’s release of any other party; and specific state-law waivers, as the case may be.
Concluding Thoughts
Personal guaranties are straightforward in concept but can have several different attributes. Choosing among full recourse, limited, and springing varieties gives the lender more flexibility in negotiating with their borrowers and guarantors, while still providing a high level of protection. You may choose any of these options at any time and to switch between them. Additionally, the addition of construction guaranty language as standard for all construction loans and spousal consents that automatically populate for the correct states ensures the highest level of protection for the lender.
If you have any further questions on guaranty types or how to use them, please don’t hesitate to contact us. If a borrower or guarantor is looking to negotiate over the precise language of the guaranty, reach out to the attorneys at Geraci LLP – they are experienced in navigating through negotiations in the guaranty and are happy to provide guidance on specific scenarios.
