The next tip for those who own, or want to own, a small business: BEWARE OF PERSONAL GUARANTEES.
I have represented several individuals in the last year who signed personal guarantees and then were sued on that guarantee. A personal guarantee can come up in several situations.
The first situation that comes to mind is when a small business enters into a contract to lease office space and the landlord requires the business owner to personally guarantee payment of the lease. Or, if a small business wants to set up an account with a new vendor, the vendor might require the business owner to personally guarantee payment for the products being provided.
In your personal life, a guarantee situation could arise where one family member signs a guarantee to secure payment for another family member. Think of a parent co-signing on a car loan for an adult child.
One of the main reasons that lenders require personal guarantees is that if the main borrower does not pay, then the lender can go after the guarantor. So in the office space lease situation, if there is a default on the lease, the landlord can sue the business who entered into the lease and also sue the owner of that business, i.e., the guarantor. If the landlord wins that lawsuit, the landlord can then go after the business’ assets, and if the business no longer has any assets by that time, the landlord can also go after the business owner’s personal assets to obtain payment. Or, in the parent co-signing for the child situation, the lender can go after the parent’s personal assets to secure payment for the loan.
Moral of the story: consider the long term consequences before you sign a personal guarantee. If you do sign a personal guarantee, you have to be willing to pay on the debt if the main borrower, whether it’s your business or your child, fails to pay. And, be sure to read all of the terms of the contract and guarantee before you sign so you understand the terms and conditions of the loan.
The information contained herein is general information not legal advice, and does NOT establish an attorney-client relationship with Lori Brown.
The next tip for those who own, or want to own, a small business: make sure you have written contracts WITH CLEAR TERMS.
I had a case a few years back where my client sold her home health business to a “friend”. The two friends decided not to get a lawyer and instead used a form contract for the sale of the business. Of course, a dispute arose after the contract was signed. The buyer had made a down payment on the purchase of the business and then was supposed to make installment payments to pay off the balance. But, after running the business for a short time, the buyer decided that she had not received what she expected and therefore she stopped making payments. The dispute ended up in a lawsuit and the case went to arbitration. The arbitrator ultimately decided that no one won the case because there was a “mutual mistake” involved, meaning the parties never really agreed on the terms of the agreement. This was a very rare result because usually in a lawsuit someone wins. In the end, both sides lost out, the seller never got her money, and the buyer did not get the business she expected.
The above situation illustrates the importance of having written contracts that lay out the true terms of the contract. When a contract ends up in court, the judge will look to the “four corners” of the contract, meaning only what it says in the contract, not some verbal side deal that was never written down. The purpose of a contract is to deal with all potential issues that could arise. You want to make sure that your written contracts “say what you mean”. DO NOT just sign a business contract, read it carefully (or have an attorney review it for you).
And, the days of a “handshake deal” do not exist anymore. I was doing legal research recently and read a quote from a case that I thought summed up this issue well and all business owners would be wise to remember:
“An agreement that is based on trust and is not documented is fine as long as there is plenty of money and as long as there are no problems. The purpose of legal agreements is to define, in advance, who has superior rights when there are not enough assets to go around.”
The information contained herein is general information not legal advice, and does NOT establish an attorney-client relationship with Lori Brown or Hymson Goldstein & Pantiliat.
 In re Moye, Case No: 07-37770 (Bankr. S.D. Tex., 2008).