The Different Types of Guaranties in Transactions
The difference between guaranty types is usually a function of how comfortable the transacting party with your creditworthiness is or if there is any other way to secure the transaction - like an asset or property.
Unlimited Personal Guaranty. An unlimited personal guaranty is a legal commitment wherein an individual pledges to be personally liable for the entirety of a financial obligation if a borrower or potential debtor (i.e., a tenant) defaults. This means the guarantor's personal assets, including finances and property, can be seized to cover the debt. Unlike limited guaranty (stay tuned), there is no cap on the guarantor's liability, making them responsible for the entire debt even if the borrower's assets fall short. This type of guaranty is often required by lenders to ensure added security and increased assurance of debt repayment. You don’t want to be an unlimited personal guarantor if you can help it.
Limited Personal Guarantee. A limited personal guaranty is a legally binding agreement where a guarantor commits to covering a specified portion or maximum amount of a borrower's or potential debtor’s debt if they default. Unlike an unlimited personal guaranty, the guarantor's liability is capped, and their personal assets are only at risk up to the predetermined limit. This arrangement offers a level of protection to guarantors by preventing their total financial exposure. Lenders commonly accept limited guarantees as they still provide a degree of security while allowing guarantors to define their potential financial risk in advance.
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Joint and Several Personal Guaranty. A joint and several personal guaranty is a legal commitment undertaken by multiple guarantors, collectively and individually, to assume responsibility for a borrower's debt. In case of default, the lender or creditor has the option to pursue any or all guarantors for the full debt amount. Each guarantor is jointly liable with others, meaning they share the burden, and severally liable, implying they can be pursued individually for the entire debt. This arrangement provides lenders with flexibility in seeking repayment and enables them to hold each guarantor accountable based on their financial capacity. Sharing a joint and several personal guaranty with someone else does not cut your obligation by half; it merely increases the number of individuals the lender or creditor can go after to recoup the debt.
Non-Recourse Personal Guaranty. A non-recourse guarantee is a type of agreement where a guarantor's liability is restricted solely to the collateral securing a loan or obligation. In case of default, the lender's recourse is limited to that specified collateral, and they cannot pursue the guarantor's personal assets beyond that collateral's value. This arrangement is common in real estate transactions, where the lender's claim is restricted to the property itself. Non-recourse guarantees offer protection to guarantors by preventing personal asset exposure, but the downside is that lenders might demand stricter collateral assessment and terms since there are no other assets to secure the loan.
Bad-Boy/Recourse Carve Out Limited Personal Guarantee: A “bad-boy” carve out limited guarantee is a specialized form of guarantee often used in commercial real estate. It involves a guarantor agreeing to become personally liable for a borrower's debt under specific "bad-boy" circumstances, such as intentional acts of fraud, misrepresentation, or actions that harm the lender's interests. In such situations, the guarantor's liability extends beyond the usual limited guarantee terms, allowing the lender to pursue the guarantor's personal assets. This type of guarantee provides lenders with recourse in case of egregious borrower behavior, adding an extra layer of protection in complex transactions.
Surety Agreement (and how it’s different from Guaranty): The terms "surety" and "guaranty" are often used interchangeably, but they have distinct legal meanings: (i) A surety is a legally binding contract where a third party (the surety) agrees to be responsible for the debt or obligation of another entity (the principal) in the event that the principal fails to fulfill their obligation. The surety typically steps in to fulfill the contractual obligations or repay the debt if the principal defaults. (ii) A guaranty is a promise made by one party (the guarantor) to be answerable for the debt, default, or failure of another party (the obligor or debtor) to a third party (the obligee or creditor). Essentially, a guarantor is providing a guarantee to the creditor that they will ensure the debt is repaid if the debtor is unable to do so. In a surety, there are three parties involved: the principal (the person with the primary obligation), the surety (the one providing the guarantee), and the obligee (the person or entity owed the obligation). In a guaranty, there are two parties involved: the guarantor (the one providing the guarantee) and the obligee (the person or entity owed the obligation). In a surety, the surety's obligation is primary. This means that if the principal defaults, the surety is immediately responsible for fulfilling the obligation. In a guaranty, the guarantor's responsibility is secondary. They are only responsible if the debtor fails to fulfill their obligation. In a surety, the obligee can typically go directly to the surety to demand performance if the principal defaults. In a guaranty, the obligee typically has to first pursue the debtor before seeking payment from the guarantor.
Goes without saying, this is not an exhaustive list of the possible permutations of guaranty concepts a lender might put together for a particular deal. Like snowflakes, each guaranty is different and unique in its own way.
