Contract


Now that we are in recovery (hopefully) from the great banking flu of 2008-2009, it has become clear that doing business with banks has changed quite a bit.  Gone are the days of quick loan approvals and business loans secured only by the underlying business.  Even more than ever, banks now look for personal guarantees from well-heeled individuals to secure a business loan, and if you are the guarantor, you need to consider several details.

 For any of you who needs a refresher on the basics of a personal guarantee, refer to my July 2009 newsletter.  The first thing you need to understand is that most guarantees are a guarantee of payment not collection.  This means that if there is a loan default the bank can show up at your door and demand payment; it doesn’t have to try to collect from the business, or other guarantors, or even foreclose on property first.  Banks are also regularly requiring guarantors to pledge liquid assets (e.g. a marketable securities account) as security for the guarantee.  This makes it even easier for the bank to recover from the guarantor immediately on default.  It also means that as a guarantor you will be required to tie up these liquid assets often for the full duration of the loan.

 If you have been asked to sign a guarantee, there are several things to watch out for.  How long is the guarantee?  Usually it will run for the duration of the loan but the guarantee will likely provide that the loan (and the guarantee) can be extended by the business without your approval.  The business can likely also agree to a higher interest rate or make other changes in the loan without your approval.  Most importantly, is the guarantee limited to a specific amount? Look carefully….it probably isn’t and that could expose you to a lot more liability than you expect.  If you have other deposit accounts with the bank, the guarantee will often provide that the bank can hold those accounts if it needs to collect from you.    The bank may be willing to negotiate some or all of these items, so make sure you ask and by all means have your legal counsel review the document before you sign.  Also it is very important that you stay informed about how the business is doing and whether it maintains the loan in good standing; the bank is not obligated to let you know if the loan falls behind.

 Many loan guarantees involve several individual guarantors which helps share the pain if the bank ever enforces the guarantee.  However the bank is usually not required to collect from all guarantors; if one guarantor has sufficient collectible assets the bank can pursue that person alone.  For this reason, many guarantors enter into an indemnity agreement to ensure that if one guarantor is required to pay more than their fair share of a loan, then all the other guarantors will reimburse them.  If you are in a transaction with several guarantors, you should also consider their personal assets and make sure you can recover from them if you get stuck paying the bank.  For example, if they have much of their wealth in retirement assets or  joint real estate with their spouse, you may have a difficult time collecting on the indemnity.

 This all  reminds me of the old poker saying….if you cant’s tell who the sucker is at the poker table, it is probably you.  Don’t be the sucker when it comes to your guarantee.

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What’s the point of a contract if I have to sue somebody to enforce it? Unfortunately, this is a question I have had to answer quite a few times over the last couple of years.  Imagine you want to enter into a business transaction with another person or business…we’ll call them the “Other Guy”…that’s a little easier than “party of the second part.”  Anyway, you sign a contract with the Other Guy and the contract has all the big words and seems to cover every possibility and you feel good about everything.  Then things don’t go as planned and the Other Guy fails to perform his part of the bargain.  Well the contract is pretty clear that the Other Guy has to perform right?  What’s the problem?

The problem is that a contract is not a gun.  You can’t waive a contract in someone’s face and make them do something they don’t want to do or can’t do.  Your primary recourse is to enforce the contract through the court system (i.e. you have to sue them).  Litigation is expensive and slow.  Even if you ultimately  prevail the cost of the process may greatly outweigh the potential contract benefits being enforced.  Further, even if you win a big judgment, you may not be able to collect if the Other Guy has no money.  Thus, in many cases even if the Other Guy is clearly breaching the contract, your most cost-effective option is to walk away.  I know some of you are thinking…where is the Corleone Family when you need them?

Now the prospect of a litigation roadblock doesn’t mean that you shouldn’t talk to an attorney if you believe you are being wronged.  You may decide to pursue the matter yourself in small claims court after a little coaching from an attorney.  There are other small and inexpensive steps short of litigation that an attorney may be able to help you with even if you have no intention of proceeding with a full law suit.  Sometimes all the Other Guy needs is a little push, and a demand letter from an attorney is enough to do the job.  I need to mention that if your contract has a provision allowing attorneys fees to be awarded if you prevail in litigation, that can often be useful leverage in obtaining cooperation from the Other Guy even when the contract dispute itself does not involve much money.  Again a review of all the facts  is important in deciding how to proceed in a contract dispute.

So what is the point of a contract?  A contract is designed to set the ground rules for a transaction and to address different conflicts that may arise and hopefully avoid surprises.  A contract does not guarantee that the Other Guy will perform.  Keep in mind that most people are honest and would not intentionally ignore or breach their obligations under a contract; however, many of them may simply find themselves in a position where they can’t perform.  They have made bad business decisions or suffered setbacks which make it financially impossible for them to live up to the terms of the contract.  Whenever you enter into a contract, you should consider things such as Who are you are doing business with? What is their experience and track record?  How likely is it that they may default? Do they have the resources to perform?  Don’t rely entirely on a contract to protect you.  Caveat emptor.

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