If one person agrees to pay the existing or potential debts or obligation of another person or for an entity such as a corporation or limited liability company, then one is said to be "guarantying" the debt and one becomes as liable for payment as if one had incurred the obligation directly. The "guarantor" is the person guarantying the debt while the party who originally incurred the debt is the "principle" and the creditor is the "guaranteed party." Under California law, if properly drafted, a guaranty is a fully enforceable obligation which allows the guaranteed party to proceed directly against the guarantor, often without having to even exhaust first any remedies against the principle.
The guaranty is a powerful and common tool both in business and real estate transactions and forms the basis for thousands if not tens of thousands of transactions in California annually. Most creditors and landlords, confronting a limited liability entity without substantial assets, will demand a guaranty from the owners of the business so that if the company becomes insolvent, personal liability may be imposed on the owners or whoever else guaranteed the debts. Landlords renting to such entities, banks granting credit lines, manufacturers providing products to distributors, all such transactions often require guaranties being provided by the owners of the entities.
If you are a creditor, such a tool is probably the single most powerful weapon in your arsenal of collection and, assuming the owners of the entity have assets, can provide payment even if the entity becomes defunct or files bankruptcy. If you are the owner of the entity seeking credit, or a person seeking to have credit provided to another person, the guaranty is a obligation to be taken seriously. It is not unusual for a father's guaranty of a son's obligation or a departing shareholder's continuing guaranty of a company she has left to result in significant liability being imposed, often years later after the guarantor may have even forgotten that the guaranty was granted.
It must be recalled that typically the guaranty applies to the debt regardless of the cause of the debt or if the principle acted wisely or foolishly. It applies whether or not the guaranteed party failed to notify the guarantor of its actions or whether or not the creditor was foolish in continuing to lend the money.
It is, in short, almost a blank check written to the creditor on behalf of the principle. Before undertaking such an obligation or, if you are a creditor relying on a guaranty, the basics described in this article should be understood and, of course, good legal advice obtained before creating such a document.
CALIFORNIA REQUIREMENTS FOR A GUARANTY
1. IN WRITING
Oral guaranties are almost never enforceable in California though many creditors have attempted to enforce them claiming that they only extended credit predicated on various oral assurances from the owners of the debtor. While the law provides that a guaranty must be written, inventive creditors have sought to impose liability on the verbal "guarantors" by claiming constructive fraud, negligent misrepresentation and piercing the corporate veil theories. These efforts are seldom successful and both the statute and common sense indicate that something as serious as a guaranty MUST be in writing which carefully lays out the principle, guarantor, and guaranteed party and whether the guaranty relates to all debts and is in effect for a specific period of time.
The writing must be executed by the Party to be charged to perform under the guaranty (the guarantor) and is usually but need not be executed by the principle and the guaranteed party. The key is to have the guarantor sign.
The writing should clearly state all elements of the guaranty and describe in some detail the process for revoking the guaranty.
The writing should indicate whether the principle must first have its funds exhausted before the creditor can seek recovery from the guarantor. (Minus clauses to that effect in the document, many courts require exhaustion of remedies against the principle first.)
The usual standard terms of any contract, ranging from clauses as to how to alter the contract to a provision providing for arbitration and attorneys fees being awarded to the prevailing party should be included and the reader is advised to review the article on Contracts as well as on Arbitration on this website for a full discussion of such terms.
The writing should specify some form of "consideration" being given to the guarantor for the guaranty. As noted in the article on Contracts, to be binding either some form of consideration must be paid to a party, or reasonable reliance and detriment must be shown for the relying party. One can not be bound to a contract unless one either gets something for such obligation or leads the other party to presume that you will perform. Mutuality of consideration, in which parties to a contract either get something for agreeing to be bound, or require the other party to give something up, is an element of most contracts, including guaranties.
Commonly, the guarantor has an ownership interest in the entity or a family interest with the principle and that fact should be recited in the guaranty. Typically, a clause will read, "X agrees to pay all debts of Y, a company in which X has an ownership interest," or "X wishes Bank to loan monies to Y and understands that Y has refused to do so unless X guaranties all obligations of Y to Bank. Bank relies on this unconditional guaranty of X to pay obligations of Y to Bank in making any loans to Y hereunder."
3. CONDITIONS OF GUARANTY
An unconditional guaranty does not place upon the guaranteed party any obligation to perform certain functions before relying on the guaranty. For example, a guaranty may be conditioned on first exhausting all efforts to collect against the principle; it may be conditioned on the debt being only for a particular type of transaction; it may be conditioned on the guaranteed party giving adequate and written notice to the guarantor of the obligations being incurred.
Most modern guaranties, however, are unconditional, placing the full burden on the guarantor without requiring the guaranteed party to do more than make demand for payment upon the guarantor whenever a debt is not paid.
Typical language in such a guaranty is:
"Guarantor unconditionally and irrevocably guarantees all obligations of X owed to Y, and waives forever any right whatsoever to require Y to first proceed against X before making demand upon Y for payment in full. The guaranty shall continue in full force and effect and may only be terminated in a writing delivered to Y thirty days before termination of the guaranty and such termination shall not eliminate the guaranty as to sums already advanced. Y shall not be required to advise Guarantor as to any sums advanced to X hereunder and it shall be incumbent upon Guarantor to keep itself fully advised as to the state of the transactions between X and Y. Guarantor shall promptly and fully pay all obligations of X to Y upon receipt of written demand for payment from Y."
Normally, a guarantor obtains all the benefits of the clauses protecting the principle. Thus, if the principle has a clause in its contract with the guaranteed party that limits the obligation or which delays when payment is due, the guarantor may rely on those protections as well: the guarantor, in effect, steps into the shoes of the debtor, no better, nor worse. It is thus a very good idea for the guarantor to carefully review all the documents binding the principle before the guaranty is made.
But the danger remains that the obligation of the principle to the guaranteed party may be altered between them without notice or warning to the guarantor and many guaranties give the guaranteed party the right to do precisely that. The careless guarantor may therefore find itself guarantying an obligation far broader and more onerous than first encountered. The prudent guarantor shall insist in the guaranty that the obligation may not be altered in its terms without prior advice and consent of the guarantor.
CREDIT APPLICATIONS AND GUARANTIES
Amidst the small print and recitals at the end of many bank loan applications as well as line of credit applications one finds guaranties slipped in which, if not carefully considered, can have devastating effect on the debtor. Our office makes it a standard practice when drafting credit applications for our clients to submit to new customers to have a guaranty provision just before the signature line for the credit application so that the potential customer is confronted with the question of whether to guaranty the debts of the corporation or limited liability company from the moment the account is opened. It is a fact of business that once the account is opened it is much more difficult to approach the principles of the business and then ask them to execute the guaranty.
To our surprise, when we take action to enforce such guaranties in the credit applications we find that many of the debtors did not even realize they were executing a guaranty when signing the credit application! Apparently after filling in the various blanks with the information the credit manager wanted, they glossed over the wording above the signature which usually provided words to the following effect: "The Applicant for the Credit hereby unconditionally and irrevocably agrees to guaranty any and all obligations of the Company to XYZ Supplier and understands that such guaranty is a condition to supplying any credit from XYZ to Company."
Other companies that we represent have the credit applicant execute a full and complete guaranty agreement using a variation of the form below:
PERSONAL GUARANTEE AGREEMENT
The undersigned GUARANTOR agrees with_____________________ (hereafter termed____________ ) as follows:
1. GUARANTOR desires to have____________grant credit terms as described on the attached Application to ____________________ (hereafter termed "FIRM"). __________________ has advised GUARANTOR that no credit will be allowed to FIRM without GUARANTOR personally guaranteeing, by this Agreement, all sums owed to ______________ by FIRM.
2. In consideration of the granting of credit to FIRM by ______________, GUARANTOR does guarantee prompt payment of any and all past, present and future charges and payments due to________ by FIRM for goods sold to FIRM by ____________________ ***OPTIONAL INDICATE "YES" OR "NO": This includes sums due prior to execution of this Agreement but unpaid at this time.*** ***OPTIONAL INDICATE "YES" OR "NO": This guarantee also covers all merchandise back ordered or to be shipped from the factory as of date of termination of this Agreement.***
3. This Guarantee is a continuing one until terminated by GUARANTOR in writing by registered mail to____________ . The termination shall be effective 15 days after receipt of written notice by____________ .
4. Should FIRM default in the prompt payment of sums due________________ , ___________________ may immediately proceed against GUARANTOR, and shall give written notice to the GUARANTOR, together with an accounting of all sums due as to which FIRM is in default, by regular or certified mail. _________________ may, from time to time, extend the time for payment or accept partial payments of or additional security for balances due or to become due from the FIRM without or prior to, such notice to the GUARANTOR. GUARANTOR hereby waives the right to require________________ to first proceed against FIRM prior to enforcing this Guarantee.
***OPTIONAL INDICATE "YES" OR "NO": 5._______ may refuse to sell to FIRM, place sales to FIRM on a C.O.D. basis, or limit the amount of credit granted FIRM at any time and without notice to GUARANTOR or the FIRM. Guarantor shall remain responsible for the invoice charges for all materials sold to the FIRM prior to the change of sales terms, or afterwards, even if merchandise is sold or credit is extended by mistake. This Guarantee shall apply to any purchases by FIRM, its successors in interest, and shall also apply to any new corporate entity which owns any or all of the assets of FIRM.***
#. Any and all notices to_______________ or to the GUARANTOR or to the FIRM shall be mailed to it, postage prepaid, at the addresses herein set forth or at such other addresses as they shall designate by a written notice to the others.
#. Any and all disputes relating to this Agreement or its breach shall be settled by arbitration ***OPTIONAL INDICATE "YES" OR "NO":, by a single arbitrator,*** in , California, in accordance with the then-current rules of the American Arbitration Association ("AAA"), and judgment upon the award entered by the arbitrator may be entered in any Court having jurisdiction hereof. Costs of arbitration, including ALL/REASONABLE attorney's fees incurred in arbitration, **CHOICE INDICATE "I" OR "II" AT: as presented to the arbitrator by the prevailing Party, OR as determined by the arbitrator,** together with ALL/ANY REASONABLE attorney's fees incurred by prevailing Party in Court enforcement of the arbitration award after it is rendered by the arbitrator, must be paid to the prevailing Party by the Party designated by the Arbitrator or Court. Said arbitration shall be conducted in the English language and the award rendered in United States dollars. Service of the Petition to Confirm Arbitration and written notice of the time and place of hearing on the Petition to Confirm the Award of the Arbitrator shall be made in the manner provided herein for all notice. Such service shall be complete on personal delivery or the deposit of the Petition and notice in the United States mail.
Should one party either dismiss or abandon his/her claim or counterclaim before hearing thereon, the other Party shall be deemed the "prevailing Party" pursuant to this Agreement. Should both Parties receive judgment or award on their respective claims, the Party in whose favor the larger judgment or award is rendered shall be deemed the "prevailing Party" pursuant to this Agreement.
***OPTIONAL INDICATE "YES" OR "NO":
At any time after the initiation of arbitration and not less than twenty (20) days prior to the arbitration hearing, any Party may serve an offer in writing upon any other Party to the action to allow an arbitration award to be made in accordance with the terms and conditions stated in the written offer. If the offer is accepted, the offer, together with written acceptance, shall be submitted to the arbitrator and an award made thereon without further hearing between those Parties. If the offer is not accepted in writing, prior to five (5) days before the hearing or within ten (10) days of mailing of offer, whichever first occurs, it shall be deemed withdrawn and cannot be given in evidence at the hearing. If the Party to whom said written offer was made fails to obtain a larger or more beneficial monetary judgment than the offer from the arbitrator after hearing, the Party to whom the offer was made must pay to the offering Party the offering Party's costs of arbitration, including, but not limited to, AAA administrative fees, arbitrator's fees and the costs of experts necessarily incurred in preparation for the arbitration, as well as all attorneys fees incurred by the prevailing Party. The attorney's fees so incurred shall form part of the judgment and shall not be reduced by the Arbitrator unless the Arbitrator determines that clear and convincing evidence has been presented that such fees are unconscionable.***
#. This instrument contains the entire Agreement between the parties relating to representations made, the rights herein granted, and the obligations herein assumed. Any modifications of this instrument shall be of no force or effect unless reduced to writing signed by all parties.
Agreed and Accepted:
For the debtor executing such a document, it is vital to understand that this will cut through the protections of limited liability found in corporations, limited liability companies, limited partnerships, etc. For the creditor obtaining such a guaranty, it does allow significant additional protection.but if the guarantor has no assets or files bankruptcy, the protection will do little good. Only security in the form of deeds of trust on real property or UCC-1 filings on equipment will provide the additional protection many creditors require.
GUARANTIES IN OTHER STATES OR COUNTRIES
It is important to recall that the above law is California law and depending on where the guaranty is entered into, the law can significantly alter. It is entirely legal for a guaranty, like any other contract, to incorporate the law of a different state.or even different country.and have it enforceable in California as long as there is some connection to the other jurisdiction and informed consent of the Parties. Given the increasingly multi state 9and multi national) nature of so much business, one should carefully note the state or country whose law is incorporated into the guaranty before assuming that the various protections of California will apply.and for creditors, they should be aware that certain states, such as Texas and Florida, have remarkable protections for debtors which may mitigate against the usefulness of the guaranty. As with so much in the modern global economy, careful consideration must be given to the locus of the transaction, the right wording to vest jurisdiction and choice of law in California, etc. Given the dangers and power of the guaranty, good legal advice is required before either drafting.or executing such an instrument.