Guaranteeing Personal Assets on a Commercial Loan
The inevitable risks and how to avoid them
Franchisees, business, and property owners who have personally guaranteed commercial loans face a challenging situation when banks seek repayment, especially in today's state of economic distress.
Lenders typically classify guarantors into three categories: (1) Well-capitalized guarantors with an expected profitable future relationship; (2) Guarantors with the potential for positive future business; and (3) Guarantors with a downside risk.
The relationship with lenders often becomes negative when guarantors fall into the third category. Guarantors in this category may experience a contentious situation with lenders and may find themselves in litigious circumstances in which money is wasted on legal fees and property values decline significantly. However, an adept financial restructuring professional can avoid a situation that can deteriorate into litigation, foreclosure, or bankruptcy, by engaging early.
Dealing with a lender in a workout or restructuring situation is quite different than the typical dealings with a lender involving originating, servicing, or refinancing performing loans. A lender's workout personnel may react more aggressively than those with whom the guarantor has worked in prior years. As a result, there are several practices to which a guarantor should adhere in navigating the unpredictability of a workout or restructuring circumstance.
Primarily, a guarantor must maintain transparency with a lender. A guarantor whose personal assets are at risk should ensure accuracy of all financial statements and should never "hide the ball." A guarantor should never move or dispose of assets, especially in a covert manner. These actions will adversely affect a guarantor's relationship with a lender and may cease negotiations. A guarantor who acts suspiciously will raise red flags, which can result in a lender taking rash measures such as filing a prejudgment writ of attachment that can inflict the guarantor with devastating consequences.
A prejudgment writ of attachment is used to secure a lender's loans taking priority over other lenders who have claims on a guarantor's assets. The writ functions like a temporary restraining order, preserving the status quo pending a final resolution. This could result in a prolonged period where the guarantor is prevented from acting freely as the writ can effectively freeze a guarantor's personal bank accounts and property. Guarantors are frequently caught off guard by the aggressive speed with which creditors act and consequently, may agree to lenders' disadvantageous conditions once a writ is effectuated.
If the dispute is not resolved within 90 days, the prejudgment writ can become seasoned, signifying a lender's perfected security interest in a guarantor's personal bank accounts and properties, including primary and secondary residences. A lender with a seasoned writ has priority over other non-secured creditors with whom a guarantor may be involved, which can adversely affect negotiations with other creditors. Responding to a prejudgment writ is not only costly and inconvenient for the guarantor, it also provides the lender with leverage that makes settlement significantly more difficult.
Therefore, in addition to maintaining transparency with a lender, guarantors should consider adhering to these supplemental strategies when attempting to settle with banks and restructuring a commercial debt:
Do:
- Provide details of the current financial condition of the business. Lenders may have different perceptions based on old financial information.
- Prepare and execute an Affidavit of Statement of Financial Condition, which incorporates a guarantor's financial activities over the last several years.
- Prepare a settlement proposal that has more favorable economic terms than a Chapter 11 or Chapter 7 plan of reorganization.
- Be proactive. Absent productive interaction toward resolution, lenders often make unilateral decisions without consulting the guarantor that can have severe consequences.
- Offer to buy-out personal liabilities at a discount with a third party. Finding a new money source to resolve past issues by settling or selling at a discount is becoming more prevalent with lenders who have adequate financial statements to complete such resolutions. Lenders have great incentive to remove non-performing or substandard loans from their balance sheet. Discounted payoffs free up reserves and enable the lender to take immediate losses and re-deploy assets into performing loans, creating a win-win situation for both parties.
Don't:
- Wait for the lender to take the initiative. Typically, the lender will not act first in order to avoid lender liability.
- Threaten lenders with lender liability litigation. This will cease negotiations and force the lender to turn to attorneys.
- Make settlement proposals that avoid taking proper account of the lender's alternatives in a Chapter 7 or Chapter 11 bankruptcy action.
Debt restructuring, discounted loan payoffs, and dealing with personal guarantees can be costly and time-consuming. A business owner facing a payment dispute should remain professional and straightforward, while aggressively attacking the problem. By taking a measured approach, a guarantor can evaluate every option and pursue the most positive and cost-effective solution.
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Steve Huntley is a founding principal of Huntley, Mullaney, Spargo & Sullivan, Inc., a financial restructuring firm. He can be reached at shuntley@hmsinc.net or 925-831-3233.
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