John Williamson, a local bank vice president, meets with Ronnie Roma and Harry Levine about a $25,000 equipment loan for their closely-held business, Highland Farms, LLC. After the initial conversation, Roma takes the lead on negotiating the loan. Levine is unaware of the progress of things until Roma emails Levine a blank “Personal Guaranty” to sign so they can “do that loan we discussed with the bank.” Because the loan is supposed to close the following day, Levine signs the guaranty that includes an obligation to guaranty all the debts of the “Debtor” to the bank, but the name of the “Debtor” is blank when he signs it and the document contains no reference to the specific transaction. Levine emails a signed copy of the guaranty to Roma.
One year later Levine receives a notice from the bank that Highland Farms is past due $200,000 on a line of credit and demands that Levine pay that amount as guarantor. Levine asks the bank for the loan documents and receives a copy of the guaranty he signed that has “Highland Farms” written in the blank next to “Debtor.” Levine calls Williamson to explain that he only agreed to guaranty $25,000 of debt for Highland Farms and had no knowledge of a line of credit. Williamson tells him “all debts” means “all debts” and demands payment. Levine, who is experiencing personal financial hardship, asks Williamson: “Why are you doing this to me?” Williamson responds “My boss is leaning on me, plus I don’t like you.”
While various state laws impose different requirements for personal guaranties, an underlying concept behind any guaranty is a “meeting of the minds” required in any contract. Some states require specificity within the guaranty to ensure that a meeting of the minds is clear. For example, Kentucky law requires that a guaranty describe or expressly reference the debt being guaranteed, the “maximum aggregate liability” of the guaranty, and the date the guaranty terminates. [i] Conversely, a Tennessee court found that a corporate officer’s signature on a credit application for the company bound the officer personally because the application included boilerplate language that personally bound the signing officer for “any and all amounts due by” the company. [ii] A guaranty that includes a “choice of law” clause (e.g., “This contract shall be governed by the laws of the State of Kentucky”) may provide guidance as to the enforceability of a “blank guaranty” for subsequent debt obligations. However, when the guaranty does not point to a specific state or if the chosen law does not require specificity as to the transaction guaranteed, uncertainty remains. That uncertainty can take the form of a challenge by the purported personal guarantor about the enforceability of the guaranty.
So, how does everyone gain peace of mind during the flurry of activity leading up to a closing? First, make sure all interested parties are “in the loop” on their obligations and knowledgeable about the transaction. Second, prudence dictates that parties to be bound not execute documents unless all the material terms are contained in those documents. Finally, the best practice is to have the signatories for any of the agreements execute those in the presence of others and with full disclosure of the terms of each document. These recommendations sound obvious, but in the stress of closing a loan, pressure may exist to cut corners, which can create significant problems in the future. Those simple steps may prevent a challenge by a purported guarantor and prevent the John Williamsons of the world from having to explain to their boss that the guaranty of $200,000 may be worthless. Conversations like that usually take people out of the running for a new set of steak knives.