Commercial loans & personal guarantees

[Jessie Dillon]

Hi all! An interesting question has come up in my circle & wondering if anyone WORKING IN commercial loans can answer this for us: 

Example:

A new LLC is created for a group of people to purchase a property in. Ownership of that LLC is split up amongst each partner's single-member LLCs. New LLC will be buying a property with a commercial loan. The group collectively contributes the down payment, closing costs, reserves, and reno $$ if applicable. Everyone involved personally guarantees the commercial loan. THE QUESTION: Under what circumstances would the personal guarantee be acted on by the lender, and how would that look for each individual if, say, there were 5 partners and each had 20% ownership?

Thanks in advance for any insight! This is obviously doomsday prepping, but it'll be interesting to know!

[Stuart Udis]

First of all, why would you each be admitted as disregarded entities and not individually? Seems like an unecessary added expense, particularly as single member LLC's. If the borrowing entity were to default on the loan, the lender will hold each responsible. When you each sign as co-guarantors you are signing jointly and severally, not for only 20% of the loan amount.

[Jessie Dillon]

@Stuart Udis Not saying this is the most effective setup lol, this is the just example we're working with. This doesn't really answer the question though. How would that play out? First of all, I'd think they would just take the property back so long as the value was equal to or greater than the loan amount.. 

[Stuart Udis]

In your example if value is not sufficient, they will hold you each accountable and if your four partners disappear, the bank can still hold you personally responsible for the entire deficit. Also, what happens if you fail to maintain proper insurance coverage and their is a total loss due to a fire? Now the land is not worth nearly as much as the collateral the bank issued their loan on.  Bank will come after you for the repayment of their loan. Same would apply in that scenario....if your partners disapperared the bank can still hold you personally responsible for the entire loan repayment. 

[Tina Williams]

In this scenario, the personal guarantee serves as assurance to the lender in case of default by the LLC. Typically, lenders will pursue personal guarantees when the LLC is unable to fulfill its obligations, such as missed payments or defaulting on the loan. If the guarantee is enforced, each individual with a 20% ownership stake would be liable for 20% of the outstanding debt. This means they could be pursued for repayment or potentially face legal action to recover the lender's losses. It's crucial for all partners to understand the implications of personal guarantees before committing to them.

[Jessie Dillon]

Quote from @Tina Williams:

In this scenario, the personal guarantee serves as assurance to the lender in case of default by the LLC. Typically, lenders will pursue personal guarantees when the LLC is unable to fulfill its obligations, such as missed payments or defaulting on the loan. If the guarantee is enforced, each individual with a 20% ownership stake would be liable for 20% of the outstanding debt. This means they could be pursued for repayment or potentially face legal action to recover the lender's losses. It's crucial for all partners to understand the implications of personal guarantees before committing to them.

 They wouldn't just take possession of the property so long as it was worth at least the amount of the debt? @Tina Williams

[Stuart Udis]

@Tina Williams The lender would not agree to a loan where each borrower is only responsible for 20% of the loan. The guarantee will be applied joint and severally amongst all guarantors. 

[Jessie Dillon]

@Stuart Udis & Stuart if it's what you're saying, where each person would be responsible for 100% of the debt, again, how would that play out? That's what we're debating

[Chris Seveney]

@Jessie Dillon

It would play out based on your operating agreement. While each of you is responsible for the debt your operating agreement could outline who is or is not responsible or how much

If there was a default then the lender would still get paid but other members may have to pony up the cash and then sue the partner(s) who did not follow the operating agreement

[Brian Burke]

If there were a default, yes, the lender would foreclose and take the property back.  If that doesn't cover the principal balance plus all accrued interest, exit fees, yield maintenance, prepayment penalties, default interest, advances made for unpaid property taxes and insurance (even forced placed insurance), advances on senior loans, foreclosure costs/fees, toxic waste cleanup, costs of resale, the list goes on and on...the lender can sue each and every one of you for the entire unpaid amount.

The way this would likely play out, should the lender elect to enforce the personal guarantee, is they would file suit naming each partner as a defendant.  When you lose that lawsuit, the court will issue a judgment against each and every partner for the full amount of the damages (which can also include court costs and post-judgment interest and depending on the terms of your loan agreement, maybe even the lender's attorney's fees for the suit).  Then it's up to you partners to figure that out.  Maybe the five of you all agree to cut a check for your 20% share.  

Or, if that doesn't happen, the first one of you to sell a house will have the proceeds of that sale yanked from you by the court before you even touch them, even if it's ten years later.  Or your bank account could be seized.  If that pays the entire judgment, now it's up to that partner to sue the other partners to recover the share of the judgment that they should have been responsible for under the terms of the operating agreement.  

Forget about the lender chasing you each for 20% because that's what your operating agreement says.  The lender isn't bound by your operating agreement, they are bound by the loan agreement, which will most certainly say that you each are jointly and severally liable (which means that each of you and all of you are responsible for the whole deficiency--basically whoever they can get to first, or whoever has the most assets for them to seize).

This is why a wealthy person wouldn't want to sign a PG with a broke partner(s).  The wealthy person would always lose, because the broke partner couldn't pay their share, and the lender will focus their energy on collecting from the person they can most likely collect from.

I've talked to many people over the years with stories of great partnerships at the start, that ultimately failed and one or more partners disappeared after things went south.  Be careful.  Or better yet, seek out a non-recourse loan if you can find one.

[Joshua Gorsky]

For what it's worth, while a joint and several guaranty is most common, I've seen and have been a part of transactions where the parties negotiated limited guaranties for each guarantor (usually based on their % ownership) adding up to the 100%. It is rare, but the concept exists. 

[Stuart Udis]

@Joshua Gorsky That's very interesting. Seen partial recourse, but still joint and severally liabile amongst guarantors. Trying to understand the mechanics of what you shared. For illustration purposes, there is a $1M loan, the lender takes back the asset for $800k & there are 3 guarantors, each with 33% ownership interest in the real estate. The lender can only go after each for $66,000 + misc. fees?

[Joshua Gorsky]

@Stuart Udis

In your hypothetical, yes. The lender will define “Obligations” and make each guarantor responsible for X% of the Obligations.

[Ronald Rohde]

Quote from @Stuart Udis:

@Joshua Gorsky That's very interesting. Seen partial recourse, but still joint and severally liabile amongst guarantors. Trying to understand the mechanics of what you shared. For illustration purposes, there is a $1M loan, the lender takes back the asset for $800k & there are 3 guarantors, each with 33% ownership interest in the real estate. The lender can only go after each for $66,000 + misc. fees?

 Usually that won't happen though, one partner will pay the $200k and seek recourse from the other partners later.