Let’s separate the issue of a full recourse loan from a guarantee as they have distinct legal differences. A loan can either be a full recourse private money loan a or non-recourse private money loan. If a loan is full recourse, it means the lender is entitled to pursue the borrower to collect on other assets owned by the borrower if the debt is not fully satisfied by the collateral. Many borrowers title assets in separate entities to guard against the full recourse nature of most commercial loans.
For example, consider a borrower who owns a 25 unit apartment complex and it is titled in his personal name. Assume the borrower gets a full recourse loan, but does not give a personal guarantee. If the borrower defaults and the lender does not recover the full amount of the debt, the lender can sue the borrower personally for the deficiency owed to the lender. Essentially, a full recourse loan to an individual is similar to a personal guarantee because the borrower is exposing himself to liability for all other assets titled to him personally because the borrower is fully responsible for the debt on a full recourse loan.
Using that same example, if the borrower owned the units in an LLC, and the LLC was the borrowing entity, the lender only has recourse against the LLC. If the LLC owns no other assets, then the lender has no legal authority to collect on the debt other than what they can recover from the collateral.
Essentially a full recourse loan is limited to the borrower. For this reason, most commercial lenders require a personal guarantee from the individual and sometimes other related entities as well so that the lender can pursue multiple avenues to collect on a debt in which the foreclosure and resale of the collateral does not satisfy the debt.
Not all guarantees are the same. There are three basic types of guarantees:
- Unlimited Personal Guarantee
- Limited Personal Guarantee
- Conditional Personal Guarantee
Unlimited personal guarantee is one in which the entity issuing the guarantee is guaranteeing the entire outstanding loan amount plus legal fees, accrued interest, and costs associated with collecting on the loan. The lender will first exhaust their remedy by foreclosing on, and selling the collateral. If the full amount isn’t collected, the lender will look to the borrower’s personal assets to recover the unrealized balance.
Limited personal guarantee sets a dollar limit or some other limit on the amount of liability and is common when there are several company shareholders involved in the loan. Be aware that limited guarantees often contain a “fraud” clause that converts an otherwise limited guarantee to an unlimited one if fraud is involved. Sometimes the fraud clauses are referred to as “bad boy” clauses.
Conditional personal guarantee requires a “trigger” event to take place in order for the guarantee to be valid. For example, a low loan-to-value (LTV) loan with minimal risk may only invoke the guarantee when certain outlined compliant conduct conditions are not met by the borrower.
Ownership of the Note Can Change
The private money lender or investor you are negotiating with may not be the person or entity that enforces the guarantee. You may have an excellent relationship with the person who is negotiating your loan, but it is a mistake to think you do not have to pay attention to the guarantee language because the person on the other side of the table is friendly, or someone with whom you’ve had a great past relationship.
Things change quickly in the lending business. Lenders sometimes sell non-performing notes at the first sign of trouble so they can cut their losses quickly. When negotiating your guarantee, think how a complete stranger may try to enforce actions. Think about what type of entity may purchase your loan in order to gain control of your collateral if things do not go as planned and you fall behind in your payments or violate other loan covenants.
One of the benefits of obtaining a private money loan is that everything is negotiable. Sometimes having the knowledge of what to negotiate (e.g. a guarantee) is the most valuable asset you have. Look at your project from the investor’s position and figure out a win-win so the investor gets a solid return for their investment risk and you receive the best terms possible for the loan you are requesting.