Will a Personal Guaranty Trump LLC Financial Liability Protection?
Erin Porta, OSUE Agricultural and Resource Law Extern and Peggy Hall, Asst. Professor, OSUE Agricultural and Resource Law Program
Like much of the business world, many Ohio farmers are choosing to operate as Limited Liability Companies (LLCs) to gain personal liability protection for LLC members and ample estate, tax, management and business succession advantages.
Under Ohio’s LLC statute (ORC § 1705), an LLC is treated as a separate legal entity apart from its owners. Thus, the general rule places the debts, obligations, and liabilities of an LLC, whether arising in contract, tort, or otherwise, solely on the shoulders of the LLC—not its members or managers. LLC members and managers stand to lose only the money they've invested in the LLC, not their own house, car or other personal possessions.
Increasingly, those who deal with LLCs are finding ways around this personal liability “shield.” One strategy that is becoming more frequent among lenders, landlords and other businesses doing business with LLCs is to require a personal guaranty from individual LLC members or managers. The personal guaranty binds the LLC members or managers to a promise to be personally liable for the debts and liabilities of the LLC.
While personal guaranties are becoming a ubiquitous part of doing business, their legal implications are far from routine. When faced with a demand for a personal guaranty, here are several important points LLC members or managers should keep in mind:
- A valid personal guaranty will negate the personal liability protection provided by the LLC. By signing a personal guaranty you are essentially waiving your LLC personal limited liability shield. For example, if the LLC cannot repay the loan you guaranteed, the creditor may come after your personal assets. However, the personal guaranty will not negate other LLC liability protections, such as liability for torts committed by the business.
- The word “guaranty” is not necessary to create a personal guaranty. There are no formal magic words required for the formation of a personal guaranty; it is sufficient if the document contains words that unequivocally create a promise to answer for the debt of another.[i] Examples of language that create a personal guaranty include: a party "guarantees" an obligation of another; a party agrees to immediately undertake the obligations of borrowers upon written notice of default from the creditor; a creditor has the right to "call" upon the LLC manager to make payments due from the LLC; or the LLC manager agrees to be "responsible for" an obligation when due.[ii]
- How you sign may matter. Ohio cases indicate that signing your name followed by your business title (“John Doe, President”) on an agreement that contains personal guaranty language does not negate personal liability or shift liability to the LLC. [iii] However, disclosing that you are representing the LLC by using “by,” “per,” “on behalf of” and indicating the name of the business may deem the agreement ambiguous and prevent personal liability. [iv] There is a major hurdle to this strategy, however: the other party must accept this form of signature—a tall order considering it would essentially render the personal guaranty agreement meaningless.
- You will almost always be responsible for the entire debt. The personal guaranty agreement will specify your obligations; however, most create unconditional joint and several liability for all who sign the agreement. In other words, each LLC member or manager who signs is responsible for the full amount of the debt and the bank may pursue any and all LLC members or managers who signed the guaranty.
- Some personal guaranties live beyond the original transaction. A guaranty may be restricted to a single transaction or may continue to apply to some or all future transactions. Phrases such as "now or at any time hereafter," "all obligations however and whenever incurred," and "now existing or hereafter contracted" are examples of language that may create a personal guaranty for future transactions of the LLC. Under Ohio law, a guaranty will likely not be interpreted as one that continues into the future absent this type of language, which displays a clear intent to be bound in the future.[v] Where the guaranty is a continuing guaranty, it remains effective until the LLC manager or member clearly communicates an intent to revoke and no longer be bound by the guaranty.[vi]
- Some lenders or property owners are willing to negotiate. While personal guaranties are becoming very common, they can be negotiable and tailored to your company's situation. Some businesses automatically include personal guaranty agreements or language in their standard business transactions and it's possible that a deal could go through without the guaranty .[vii] For example, an LLC that can show adequate capital in its reserves may be able to negotiate a loan without a personal guaranty. Alternatives to a personal guaranty, such as larger security deposits or letters of credit, may also be negotiated. If the person or business insists on having a personal guaranty, there are still ways to limit personal risk such as proposing an endpoint to the guaranty when certain conditions are met (dollar amount caps, no default for a set period of time); subjecting only certain personal assets to the guaranty; ensuring the guaranty is limited to the particular transaction at hand and not future transactions and exempting a spouse of an LLC manager or member from the guaranty.
- Ignorance is not bliss. Claims that a party thought he or she was signing something other than a personal guaranty, did not read the entire document, or was not made aware of the personal guaranty have generally not been well received by Ohio’s courts as reasons to negate a personal guaranty.[viii] To void a personal guaranty on the basis of "ignorance," there must be evidence demonstrating that a party committed fraud in securing a personal guaranty from another party—a hard standard to meet.
- Personal guaranties are not the only way to waive LLC personal liability protection. Be aware that co-signing a loan, signing a contract in your own name, pledging personal property as collateral, acting without authority, or making fraudulent representations or omissions when applying for the loan may also place your personal assets at risk.
Nearly any sort of business deal can involve a personal guaranty. The following recent Ohio court case [ix] demonstrates how a simple personal guaranty can have lasting consequences:
- The owner of an Ohio building company submitted a credit application to a supplier in order to purchase materials on credit. As part of the credit application, the owner signed a personal guaranty for the company's transactions. The guaranty included language stating that it was “a continuing guaranty for all sales heretofore and hereafter made” between the two companies until “the time that notice of the termination of this guaranty shall be received, in writing, by personal mail at the principal office of (the supplier).”
- Upon approval of the credit application, the owner of the building company purchased materials on credit and promptly paid the supplier in full. The owner of the building company then continued to purchase materials from the supplier on credit for over a decade and the building company paid the amounts due. However, thirteen years after the personal guaranty and original purchase was made, the building company was unable to pay for its purchases.
- The supplier alleged that the owner of the building company was personally liable by way of the thirteen year old personal guaranty, which the building company owner had failed to terminate or revoke in writing.
- The court enforced the personal guaranty, despite the building company owner’s belief that he guaranteed payment only for the original purchase of materials. In holding the building company owner personally liable for the company's debt, he court pointed to the language in the original guaranty which used the word “continuing,” and noted that the guaranty did not have language limiting its duration or application to any specific purchase.
This case is a good reminder that failing to understand or negotiate personal guaranty language can lead to serious and unintended results for the managers or members of LLCs. * * * For information on organizing an LLC, see Robert Moore & Barry Ward, OSU Extension, Fact Sheet: Starting, Organizing, and Managing an LLC for a Farm Business, available at http://ohioline.osu.edu/bst-fact/pdf/LLC_Farm_Business.pdf.