A Lender's Favorite Leverage
Know how to deal with the 'joint several guaranty'

Nothing is certain but death and taxes and taxes are a particularly painful certainty this time of year. Another certainty familiar to small business owners and investors in closely-held entities that want to borrow money from a commercial bank is the phrase, “This loan will require the joint and several guaranty of all of the principals.”

By requiring a guaranty, the principal’s personal assurance to satisfy the financial obligations of his or her closely-held entity, the loan officer achieves one of a bank’s primary objectives, which is risk reduction. (This phrase simultaneously preserves the loan officer’s job security.) Unfortunately, while a personal guaranty reduces risk to the bank, thereby helping your loan officer sleep at night, it has the opposite effect on the real estate investor or small business owner whose financial risks are increased.
Careful strategy and negotiation by business owners and real estate investment principals who might find themselves in the uncomfortable position of “guarantor” is important.

Since banks usually insist upon the execution of personal guaranties in order to extend credit, the question for savvy borrowers is how can you get a loan on a non-recourse basis, without the personal guaranty of the borrower? How can the guarantor’s role be diminished?

STRATEGY 1: Consider other lending sources besides a bank. High quality commercial real estate with stable rental income and creditworthy tenants may qualify for long-term fixed-rate, non-recourse loans of 10, 15 or even 20 years, at rates significantly below the prime rate of interest. Currently, rates are approaching seven percent, depending upon property type and loan parameters, from the Commercial Mortgage-Backed Securities (CMBS) market and insurance companies. These lenders offer non-recourse credit, relying solely on the underlying property for their collateral, though, in every case, personal liability will attach in cases involving fraud and hazardous waste.

Due to their advantageous funding structures, CMBS and insurance lenders often charge interest at rates significantly lower than commercial banks.

STRATEGY 2: Negotiate on the front end for personal guarantees to be released upon the achievement of certain financial benchmarks. If execution of a personal guaranty cannot be avoided, the transaction documents should include language that specifically outlines when and under what circumstances personal guaranties will be reduced or eliminated.

For example, personal guaranties might be released when the debt service coverage ratio exceeds a predetermined level or the occupancy of the property exceeds a designated percentage. Also, the guaranty might be modified or eliminated when the loan amount is reduced to a certain figure. Without getting this kind of language in the loan documents prior to closing, however, subsequent removal of a guaranty could be extremely difficult.

STRATEGY 3. Negotiate for proration of personal guaranties, instead of a joint and several guaranty. Generally, closely-held borrowers with multiple owners, shareholders or partners will be asked that all principals guarantee the entire indebtedness of the entity.

For example, a $5 million mortgage loan to a limited liability company owned by three members would result in a $15 million joint and several guaranty. The guaranteed sum could reach $30 million if each member was married and their spouses were required to provide a personal guaranty as well. In this scenario, you would be wrong to assume that each member is only liable for one-third of the indebtedness, corresponding to each one-third ownership interest.

In fact, a joint and several guaranty means that each member is personally responsible for the entire indebtedness. Borrowers may want to negotiate that each individual owner, shareholder or partner will only guarantee such portion of the loan amount as equals their ownership interest in the borrowing entity.

STRATEGY 4. Use a personal guaranty as leverage in negotiating other loan terms. If providing a personal guaranty cannot be avoided, or if for some reason the provision of a guaranty is not troublesome, remember that other favorable terms may be negotiated based on the additional security provided and the corresponding reduction in the bank’s risk. For instance, by providing a personal guaranty, is it possible to increase the loan amount so as to reduce the amount of cash equity required?

The real estate investor or business owner who enters into personal guaranty arrangements without due consideration may be marked by lenders as a poor risk and a borrower who has “little to lose.” Just as creditors attempt to reduce risk by requiring guaranty agreements, the prudent borrower will attempt to reduce individual risk by avoiding personal guaranties or, at least, minimizing their impact whenever possible.

Jamie Schrader is the owner of Advantage Lending LLC, a commercial mortgage brokerage company in Lexington.
advantagellc@gateway.net


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