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Personal Guaranty: Get One Before Giving Payment Terms

Personal Guaranty: Get One Before Giving Payment Terms
Pat Dickson - Wed Nov 14, 2012 @ 04:54PM
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Time and time again, I see small business owners getting ripped off because they gave their customers payment terms without first requiring a personal guaranty (by the way, "personal guaranty" and "personal guarantee" mean the same thing - there are just two different spellings for it).

When it comes time for the small business owner to be paid, the check is not in the mail. Long story short, the customer's corporation or LLC is broke or filing bankruptcy. If it wrote and sent a check, it would bounce

Yet, the small business owner's impulse is to call up the person he gave the payment terms and demand he make payment. The answer received is "I'm sorry. This is a business debt, not a personal debt."

It doesn't seem fair, and maybe it isn't, especially if the customer is really the sole owner of the corporation or LLC that was given the payment terms in the first place. After all, the owner signed off on the payment terms offered along with the goods or services provided. He personally agreed to make payment, right? The answer is no. If this sole owner of the debtor corporation didn't sign a personal guaranty, the small business owner/creditor is usually out of luck.

Why? How can this be? The law protects individuals from business financial obligations so long as they are acting as employees or agents of a corporation or LLC. This is the case even if the person you are dealing with is the sole owner of the corporation or LLC. A personal guaranty gets around this problem. By signing a personal guaranty, a person, even if a sole owner of an LLC or a corporation, is on the hook to pay his business's debt, even if the business cannot make payment.

The legal concept, or belief, behind an owner being able to use a corporation or LLC as a scapegoat for what should be his personal obligations is that people will be more willing to start businesses if they have limited personal liability. They are only obligated to the extent they contribute money or assets to their LLCs or corporations in exchange for equity, stock, or other forms of compensation. This subject is complex and won't be addressed any further in this article.

The takeaway is that when dealing with corporations or LLCs, obtaining personal guarantys from customers before extending them any credit can be a very wise practice. Otherwise, if you are not paid your only recourse may be an empty bank account of a defunct or bankrupt LLC. You might have a great collections department, but if there is no money to collect... You know the cliche. Blood from a Stone. 

So here is the RULE: before giving any company or business payment terms for services rendered, materials or products delivered, get a personal guaranty of the debt or obligation. If you are told NO, then make them prove the business (LLC, corporation, or otherwise) you are dealing with is credit worthy. If you don't, then if the business ends up defunct or bankrupt, you won't have any money to collect even if you take them to court and get a judgment. However, if you have a personal guaranty, you will have a person to go after, personally.

Personal guarantys are a promise to pay a business debt when the business cannot pay. Always get them when you can! And of course, personal guarantys are only good if the person signing them has sufficient money or assets. 

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