How Your Business Creditors Use Personal Guaranties to Avoid the Corporate Shield
The corporate shield that protects your personal and family assets is the most important advantage of forming a corporate entity through which to operate your San Diego business. When formed, a corporation or a limited liability company (“LLC”) legally becomes a separate entity with its own rights and ability to enter into contracts. Thus, if the corporation or LLC signs an office lease and then defaults, the landlord can sue the corporate entity because that is the legal entity that signed the lease. The landlord cannot sue the owners of the corporate entity because those owners are separate natural persons (or entities) that did not enter into the lease. This is the gist of the corporate shield.
California professional corporations are another example of allowable corporate entities. Contact our office and we can provide advice and counsel with respect to the best corporate form for your business. There are other advantages of forming a corporate entity including tax treatment, ability to establish and manage a business credit rating, immortality, ease of transfer, privacy, and more.
That being said, creditors — particularly financial institutions — are fully aware of the shield that the corporate entity provides. That is one reason that many creditors routinely insert a personal guaranty into their contracts. Many times, the personal guaranty is “buried” in the text and sometimes business owners fail to notice it. Signing a personal guaranty has the effect of making you, the owner, personally liable for the business debt or obligation if there is a default. Legally speaking, a personal guaranty is the business owner’s personal promise to be responsible for a business loan, lease, or contract. Under California law, if there is a default, the creditor or landlord or other party to the contract does not have to sue the business first; both the business and the owners can be sued at the same time. Signing a personal guaranty means a lawsuit is filed against the owners personally. If there is a judgment, personal and family assets will be at risk.
For these reasons, great care should be taken with business contracts. The best business practice is to have all of your business contracts reviewed by an experienced San Diego corporate attorney. As noted, some business owners will miss the personal guaranty language or not fully understand the legal significance of the language in the contract. If your trusted San Diego corporate attorney cannot negotiate a removal of the language, there are other options like carve-outs, etc. Of course, there are times when signing a personal guaranty is unavoidable. Many lenders will not issue a loan to a small corporation without a personal guaranty from the owners. Personal guaranty clauses are also common agreements with respect to vehicle and equipment leases, supplier and vendor contracts, office and commercial leases, and the like. Again, the key is to have such contracts reviewed and be fully informed concerning the legal effect of a personal guaranty if you agree to sign.
Contact San Diego Corporate Law
For more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard focuses his practice on business law, transactional, and corporate matters and proudly serves business owners and residents in San Diego and in the surrounding communities. Mr. Leonard can be reached at (858) 483-9200 or via email. Mr. Leonard. Like us on Facebook.