A personal guaranty contract can help lenders recover a debt, even after the property securing the debt has been foreclosed upon.
Under the California one-action rule, “[t]here can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property.” Cal. Code Civ. Proc. § 726(a). Thus, a lender can only pursue “one action” against a borrower, such as a trustee’s sale, judicial foreclosure, or filing a suit on the promissory note. California courts interpret this rule in conjunction with another, the “security-first” rule, which requires a lender to pursue recovery from real estate before suing the borrower personally. See Walker v. Community Bank, 10 Cal. 3d 729 (1974). Lenders are limited in their recovery, however, as they may foreclose upon a property securing a loan and still be left with a deficit.
Enter the personal guaranty.
A personal guaranty contract in private lending is a legally binding promise between a Guarantor and a lender that the Guarantor will personally and individually satisfy the debt obligation of the loan to the lender. A personal guaranty is a valuable protection for private money lenders, who often work with borrowers that do not qualify for traditional, institutional loans but may be backed by individuals with substantial personal assets. The following is an overview of personal guaranties and the opportunities they provide to private money lenders to satisfy outstanding debts.
A personal guaranty is generally included in the loan application papers but is a stand-alone contract between the lender and an individual “guaranteeing” re-payment of the loan by the borrower. Thus, even after the property securing a private money loan has been foreclosed upon, a lender may still satisfy the deficit of the loan by filing suit for breach of contract. The contract – the personal guaranty – promises that the Guarantor will re-pay the loan out of personal assets if the individual or business entity taking out the loan is unable to.
Under the terms of a properly drafted personal guaranty, the Guarantor promises to pay the borrower’s loan in-full from his or her own personal assets. Private money lender’s seeking to enforce a personal guaranty have the ability to enforce their judgment against the Guarantor’s personal assets, such as banking accounts, vehicles, real and personal property, and any other liquid assets the Guarantor may possess.
Personal guaranties come in two forms: unlimited and limited.
Unlimited Personal Guaranty
An unlimited personal guaranty is aptly named. It guarantees the total debt obligation along with any additional expenses which are incident to the debt, including interest, collection cost, and attorney’s fees for enforcement of the contract.
An unlimited personal guaranty allows lenders to recover their entire interest in the loan and the associated costs.
Limited Personal Guaranty
A limited personal guaranty limits the lender’s ability to collect by a specific sum. Limited personal guaranties set a maximum threshold amount for the borrower’s liability. Limited personal guaranties are most commonly used when business partners take out a loan on behalf of their company, and they apportion the risk of default between themselves, personally.
Some limited personal guaranties include a provision stating that in the event of the borrower’s fraudulent behavior or other bad act, a limited personal guaranty may be converted into an unlimited guaranty.
Personal guaranties provide private money lenders with reassurance that they will be repaid on their hard money loans. Seeking enforcement of a personal guaranty contract can serve many purposes. Not only does a personal guaranty carry with it the possibility of payment of the underlying debt, enforcing a personal guaranty can spur borrowers to engage in settlement discussions and protect lenders from borrower’s who attempt to hide assets behind the corporate veil.
A personal guaranty, often an afterthought in the loan transaction process, can be a valuable tool for lenders seeking post-foreclosure relief.
