Stoll Keenon Ogden PLLC | Advertising Material
Virtually all business is transacted these days in some form of limited liability entity, such as a corporation or LLC.
One of the primary purposes of these entities is to shield the owners of the entity from personal liability for the debts and obligations of the entity. This is particularly useful in the event of business failure or when all of the trade accounts cannot be paid, or in the event of a catastrophic, uninsured personal injury loss or the like.
However, as anyone who has tried to do otherwise has learned, the banks providing the financing for these entities (except in very rare circumstances) require personal guaranties from the owners so that they do become personally liable for the bank debt in the event that the entity cannot pay.
One frequent misunderstanding among owners of these entities has to do with the extent of their liability on this guaranteed debt. If an entity has four equal owners, often times those four equal owners will assume that they each are personally liable for one-4th of the company’s debt. That is usually not the case. Ordinarily, each one of the guarantors is responsible for 100% of the corporate debt. When trouble comes, the bank will sue all of the owners on the debt, but it will collect the debt against whoever is the easiest target. If, therefore, one owner is substantially better off financially than the others, that owner should expect the bank to chase him/her for the entire debt.
In some cases, it may be possible to negotiate with the bank at the time the loan is made to limit the exposure of each of the owners to his ownership percentage of the debt. It is the rare case when the bank will agree to do this, particularly if there are financially strong and financially weak owners, though it is worth talking to the banker about when the loan is made – after default, it is too late to have this discussion.
One footnote. If the guaranteed debt payment falls disproportionately on one or two of the shareholders, law generally allows those shareholders to seek contribution from the other guarantor-shareholders to equalize the burden. If those financially weaker owners have assets, this remedy may be available, but by the time the business goes south, it is frequently too late for this remedy to be effective.
The key is for the shareholders to know at the time the guaranties are signed that each is likely going to be responsible for the entire debt. It may be possible for one owner-guarantor to provide some personal security to the others to secure his/her duty to contribute, but the time to know all this is up front, not once the entity has failed.