Before You Sign a Personal Guaranty: What Michigan Business Owners Should Know

Sooner or later, most small-business owners are asked to sign something personally. A bank wants it before approving a line of credit. A landlord wants it before signing the lease. A key supplier wants it before extending terms. The document is a personal guaranty, and it changes the deal in a basic way: if the business does not pay, you may have to.

Forming an LLC or corporation generally keeps the company’s debts off your personal balance sheet, but that protection does not reach a debt you have personally guaranteed (see our post on why an LLC is worth the extra step). Guaranties are a normal part of small-business finance, and refusing to sign one is not always realistic. Understanding what you are agreeing to, and what you can ask to change, is.

What a personal guaranty is

A guaranty is a promise to pay someone else’s debt if that person does not. The business remains the borrower; you become a second source of payment. Michigan treats the guaranty as a separate agreement from the loan itself. In Comerica Bank v. Cohen (2010), the Michigan Court of Appeals, quoting the Michigan Supreme Court, described a guarantor’s liability as resting on “an independent collateral agreement” to pay if the borrower does not.

Two rules about form are worth knowing. First, under Michigan’s statute of frauds, a “special promise to answer for the debt, default, or misdoings of another person” is void unless it, or a note or memorandum of it, is in writing and signed by the person to be charged (MCL 566.132(1)(b)). Second, how you sign matters. Signing only as an officer of the company generally binds the company, while a second signature as an individual, or a separate guaranty document, is how personal liability is usually created. The Michigan Supreme Court has likewise held that personal liability must be clearly expressed and will not be inferred from ambiguous language. Our post on Sullivan v. Miller shows a court working through exactly that question.

Michigan courts read a guaranty like any other contract, giving its words their plain meaning, and a guarantor cannot be held to more than the document says. Both points cut the same way: the exact wording decides what you owe.

Guaranty of payment or guaranty of collection

This distinction decides how quickly a lender can come to you. A guaranty of payment is absolute: when the debt is due and unpaid, the lender can demand payment from the guarantor without first suing the business or selling the collateral. A guaranty of collection is conditional: the creditor generally must first make a reasonably diligent effort to collect from the borrower, which ordinarily means getting a judgment against the borrower and trying to collect it, before turning to the guarantor.

The guaranty in Cohen said in so many words that it was “a continuing Guaranty of payment and not of collection.” The guarantor argued that the bank should have foreclosed on the real estate securing the loan before coming after him. The Court of Appeals disagreed: under the plain language of the guaranty, the bank did not have to foreclose or proceed against other collateral first. Look for that phrase in any guaranty you are asked to sign.

How much are you guaranteeing, and for how long?

Guaranties vary widely in scope, and the scope is set by the document. Three features to look for:

• A guaranty can be unlimited or capped. An unlimited guaranty covers the full debt plus interest and collection costs. A capped guaranty limits your exposure to a dollar amount or a percentage. The guaranty in Cohen was limited to 30% of the main loan (plus all of a smaller equity loan), and the court enforced it as written.
• It can cover one loan or everything. Some guaranties cover a single loan. Others cover “all existing and future indebtedness” of the business to that lender, which can sweep in credit the business takes on years later.
• It can be continuing, which means it stays in effect as the balance goes up and down. The Cohen guaranty said it “remains effective whether the Indebtedness is from time to time reduced and later readvanced or entirely extinguished and later reincurred.”

One more lesson from Cohen: the guarantor argued that the bank’s recovery from selling the real estate should reduce his share. The court held that, under the guaranty’s terms, his capped share remained due, and any money the bank collected elsewhere would not offset it unless the bank would otherwise recover more than the full debt. A cap limits your exposure, but it may not work the way you expect unless the language says so.

The waivers in the fine print

Many guaranty forms include waivers, and the court in Cohen enforced them as written. The guarantor there had waived any right to require the bank to proceed against the borrower or the collateral first, and had waived notice of default. Even where a guarantor is entitled to notice, the court explained, a failure to give it discharges the guarantor only to the extent the failure caused actual loss. Read the waiver paragraphs closely; they often decide the case.

Be careful, too, with informal reassurances. Michigan law bars a suit against a financial institution to enforce its promise to lend, to renew, extend, or modify a loan, or to waive a loan provision, unless the promise is in writing and signed by the institution (MCL 566.132(2)). A banker’s spoken assurance that the guaranty is “just a formality” is not something you can count on.

When the business closes or files bankruptcy

A guaranty is designed for the day the business cannot pay, so it does not end just because the business winds down. Bankruptcy works the same way. The automatic stay, the pause on collection that takes effect when a business files bankruptcy, applies to actions “against the debtor” (11 U.S.C. § 362(a)). And a discharge, the bankruptcy order releasing the debtor from its debts, “does not affect the liability of any other entity on” that debt (11 U.S.C. § 524(e)). In practice, the business’s bankruptcy generally does not prevent a lender from pursuing a nonbankrupt guarantor.

What about your spouse?

Federal law limits when a lender can require your spouse to sign. The rule is Regulation B, the federal regulation that implements the Equal Credit Opportunity Act. It allows a lender to require personal guaranties from a business’s partners, directors, or officers, and from the shareholders of a closely held corporation, even if the business itself is creditworthy. The spouse protections then apply to the guarantor’s spouse as well. If the applicant qualifies on its own, the lender generally may not require a spouse’s signature. If the lender needs an additional party, it may ask for a guarantor, but it may not insist that the guarantor be the spouse. Different rules apply where a spouse’s signature is needed to reach property offered as security or jointly owned property relied on for the credit. (12 CFR 1002.7(d); Official Interpretation 7(d)(6).)

Whether your spouse signs matters in Michigan. Many married couples own their home as tenants by the entirety, and a judgment lien does not attach to real property owned that way “unless the underlying judgment is entered against both the husband and wife” (MCL 600.2807(1)). A guaranty signed by one spouse and a guaranty signed by both can therefore leave very different assets exposed.

What to negotiate before you sign

Lenders and landlords do not always agree to changes, but many terms are negotiable, especially for a business with a track record. Worth asking for:

• A cap, either a fixed dollar amount or a percentage of the debt, written so it is clear how payments from other sources affect it.
• A guaranty limited to the specific loan or lease, rather than all existing and future debts of the business.
• A burn-off or step-down, so the guaranty shrinks or ends after a period of on-time payments or once the loan balance drops.
• A release when you sell your interest or leave the company, with the release in writing.
• Written notice of default and a chance to cure before the lender demands payment from you.
• Where several owners are guaranteeing, a limit tied to each owner’s share rather than each owner being responsible for the full amount.

Whatever you agree to, keep a signed copy with your business records, note which debts it covers, and revisit it when the business refinances, adds credit, or changes owners.

Frequently asked questions

Does my LLC protect me if I signed a personal guaranty?

Not for that debt. An LLC or corporation generally shields owners from the company’s debts, but a personal guaranty is your own promise to pay. If the business defaults, the lender can pursue you under the guaranty.

Can the lender come after me before going after the business or its collateral?

Often, yes. If the guaranty is a guaranty of payment, Michigan law treats it as absolute, and the lender need not first sue the business or foreclose on collateral. In Comerica Bank v. Cohen (2010), the Court of Appeals held that a bank did not have to foreclose on real estate before collecting from the guarantor. A guaranty of collection works differently.

Does a personal guaranty end if the business closes or files bankruptcy?

Generally, no. The guaranty exists for exactly that situation, and the business’s bankruptcy ordinarily does not eliminate a guarantor’s separate obligation. Under 11 U.S.C. § 524(e), a discharge of the debtor’s debt does not affect anyone else’s liability for it. Ending a guaranty usually requires paying the debt or getting a written release from the lender.

Can a lender require my spouse to sign the guaranty?

Generally, a lender may not require your spouse to guarantee a business debt simply because you are married. Regulation B allows a lender to require personal guaranties from owners or officers in appropriate circumstances, but it generally cannot automatically require their spouses to sign as well. Different rules can apply when the spouse’s signature is necessary to reach property being offered as security or property relied upon in extending the credit.

Related reading: Michigan business formation, contracts, and ongoing counsel, when a personal guaranty fails in a bankruptcy case, when a company credit card creates personal liability, and why an LLC is worth the extra step.

Please note: This article is provided for general educational and informational purposes only and does not constitute legal advice. Reading it does not create an attorney-client relationship between you and the Law Offices of Maynard F. Newman, P.L.L.C. Guaranty obligations depend on the specific language of the documents you sign and on the facts of your situation, and the law may change; confirm the current law before relying on any summary. You should consult a qualified Michigan attorney about your own circumstances before acting. This content may also be considered attorney advertising.