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This example illustrates the risks of personal guaranties. What could be done to remove this risk, other than not signing personal guaranties? Some of the issues are reviewed at Discussion. Barbara is the current executive director of a nonprofit corporation; Jim is a former board member. |
Example
Jim: Are you the current executive director of CBA?
Barbara: Yes I am.
Jim: I was on the board of directors back when Susan was executive director.
Barbara: That would be what, five years ago?
Jim: I guess so. Say, I got a telephone call from Last Chance National Bank telling me that I owed money to them under a personal guaranty I gave on CBA's line of credit. They want me to pay $15,000.
Barbara: Well, CBA has lost all of its funding so we're going to have to shut down the agency.
Jim: Did CBA ever pay the line of credit loan?
Barbara: No, we got some extensions, but it doesn't look like we'll be able to pay it back.
Jim: Well why am I still liable? I haven't been on the board of directors for five years.
Barbara: I don't know. I didn't know any of the directors had signed any personal guaranties. That all happened before I became executive director.
Personal guaranties are contracts by one person to pay the debt of another person. Banks and other vendors may require personal guaranties from officers, directors or both as a condition to making a loan, opening a trade account, or entering into a major contract.
By their terms, most personal guaranties remain in effect against the person signing them until the obligations described in the personal guaranty are fully performed. That is, if a loan has a term of ten years, and the guarantor's board term is only three years, the obligation of the guarantor doesn't end with the expiration of his or her term as a director. It's a personal obligation, not an obligation associated with being a director.
It can be extremely difficult to get released from a personal guaranty, particularly if the lender or vendor who holds the personal guaranty has concerns about the ability of the nonprofit corporation to perform.
You should consider very carefully whether to ever sign a personal guaranty. If you do sign, make certain you understand the risks. If you decide to sign, try to limit the term, or at least your maximum exposure.
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