In California, one of the many attractive benefits of forming a Corporation (whether S or C-Corp) or Limited Liability Company (LLC) is the protection it offers the business owners from the business' debts and liabilities. Many, if not all, lenders and others that extend credit to one of these companies are cognizant of the protection these entities provide.One way lenders can still hold an individual liable for a corporation's or LLC's debt is to have that individual guaranty the company's contract. The person that signs a guaranty promises to pay the debt for the entity that signs the contract in the event of default.
For example, ABC Corp takes out a small business loan with X Bank. Before X Bank lends money to ABC, X Bank will require John Director, a principal of ABC Corp, to sign a guaranty for the loan. Several months later, ABC Corp defaults on the loan. X Bank now sues ABC Corp and John Director personally for the balance due. In this situation, if a guaranty was not signed, X Bank could only go after ABC Corp and not John Director.
Both the guarantor (the person that signs the guaranty) and the lender can learn from this scenario.
Depending on the circumstances, John Director in our example, might be able to show that the guaranty is not enforceable. If he can do this, he avoids liability on ABC Corp's loan. One way he can accomplish this is to show that the guaranty lacked a critical element of contract formation - for instance, mutual assent, consideration, lawful purpose, etc.
From the lenders stand point, in order to have the guaranty hold up in court (or arbitration), all the elements of contract formation must be met if the lender wishes to have a valid guaranty.
If you signed a guaranty and have questions or would like assistance in drafting a guaranty, please feel free to contact our office for assistance.
Scott D. Wu is an attorney licensed to practice in California. His firm focuses on various aspects of business law, contract drafting and negotiation, family law, personal injury and real estate.
The information on this blog is not legal advice, nor is it intended to create an attorney-client relationship. Legal questions should be directed to a lawyer of your own choosing.
