Can You Get Out of a Personal Guarantee? 6 Routes That Sometimes Work

The signature on a personal guarantee is the shortest thing an owner writes at a loan closing, and the only one likely to outlive the business. You can get out of a personal guarantee, though seldom by argument alone. The routes that work are a release the creditor signs, a defense the document forgot to waive, a limit bargained for in advance, or a court order that reaches the owner as a person.

Every kind of creditor asks for one: the bank on the term loan, the SBA lender, the equipment lessor, the landlord, the merchant cash advance funder. The six routes below differ less by creditor than by timing. Some open only before a default. One opens only after the owner has stopped hoping the business will pay.

1. A Payoff or a Sale Ends the Guarantee Only When Someone Says So in Writing

A guarantee of a single loan should, in principle, have nothing left to secure once that loan is paid. The trouble is the continuing guarantee, the form that promises payment of every obligation the business owes the lender now or later, which lenders often use as their standard form. Refinance the term loan with a second bank, and the first bank's guarantee may still reach the overdraft line, the business card, and the equipment note nobody remembered was booked at the same institution.

The guarantee is, to be exact about it, a second contract, not a clause in the first. Paying off the first contract does not by its own force terminate the second. What ends it is a release, or a letter terminating the guarantee as to future advances, signed by the lender. A payoff letter that confirms a zero balance may say nothing about the guarantor at all.

A sale of the business raises the same problem with a larger cast. The buyer may assume the loan and the lender may consent, and the seller may still be bound, because consent to an assumption and release of a guarantor are separate acts. The seller's opening is the closing itself (a lender whose borrower is changing hands usually needs to approve something, and the price of that approval can include releasing the old guarantor in exchange for the buyer's guarantee, provided the lender finds the buyer's credit acceptable, which is the lender's judgment and not the seller's).

SBA's rulebook shows how lenders regard owners who try to shrink their way out. For a new 7(a) or 504 application, a person who was subject to the guaranty requirement six months before applying stays subject to it after dropping below the 20 percent ownership line, unless completely divested. Selling a sliver of stock is not an exit.

The release, when it comes, is usually one page.

2. A Settlement Releases Whoever It Names

When a business negotiates a reduced payoff with any creditor, the guarantee follows the settlement only as far as the paper carries it. The uniform text of UCC 3-605, written for promissory notes and other instruments, states the default: a release of the principal obligor discharges the secondary obligor to the same extent, unless the terms of the release provide that the holder keeps the right to enforce against the secondary obligor. A creditor that intends to keep the guarantor writes that reservation in.

A guarantor who is not a party to the settlement is, in the settlement's eyes, a stranger who still owes money.

The guarantor belongs in the release by name, and the guarantee belongs there by date, along with the creditor's assignees and servicers. A settlement paid by the company and silent about the owner has bought peace for one of two defendants.

3. The Defenses Exist, and Most Guarantees Were Drafted to Waive Them

Material modification is the defense owners reach for first. If the lender and the business change the loan without the guarantor's agreement, the guarantor may be discharged to the extent the change would cause a loss; that is the rule in UCC 3-605(c)(2) for instruments, while state suretyship law and the guarantee's own words govern the separate guaranty contracts most lenders use. Subsection (f) then takes much of it back. No discharge follows if the guarantor consented, or if the guarantee waives suretyship defenses in general language. And consent by the borrowing company counts as consent by a guarantor who controls that company.

Read that last rule with an owner in mind. The person who signed the amendment as managing member is the same person now asking to be discharged as guarantor, and the uniform text treats the first signature as answering the second. Whether that rule should bind an owner who signed the amendment under the lender's deadline, in a week when the alternative was a default notice, is a question the statute does not stay to consider.

Time is the second defense. New York gives six years for an action on a contractual obligation under CPLR 213(2); other states set their own periods, and the guarantee's choice of law clause may decide which one applies. When the clock started is a question for counsel with the documents in hand.

Fraud in the inducement completes the usual list, though the paper that carries these guarantees tends to include a sentence about reliance that the signer initialed and, in most files, did not read.

4. A Limited Guarantee Is Bargained For Before the Money Moves

A guarantee of collection is a different promise from a guarantee of payment. Under the uniform rule in UCC 3-419(d), a signer who unambiguously guarantees collection pays only after a judgment against the borrower goes unsatisfied, the borrower is insolvent, or payment from it is otherwise plainly unobtainable. SBA itself permits limited guaranties from people outside its full-guaranty rule, using payment limitations on its Form 148L.

Caps by dollar amount, by percentage, or by time are all negotiable. It is the cheapest exit on this list, and the only one that must be purchased in advance.

5. Personal Bankruptcy Discharges the Promise and Leaves the Liens

The company's own bankruptcy protects the guarantor about as well as a building's sprinkler system protects the car parked across the street. The automatic stay belongs to the debtor, and the Second Circuit has said that stays under section 362(a) are limited to debtors and do not reach co-defendants who have not filed. An LLC in chapter 7 receives no discharge in any case.

An individual can. Under 11 U.S.C. 727(b), a chapter 7 discharge releases the debtor from debts that arose before the order for relief, except those section 523 carves out, and liability on a guarantee signed before the filing is such a debt. The carve outs matter here. A creditor that relied on a materially false written financial statement may ask the court to except its claim under section 523(a)(2)(B), and it must bring that request itself; nothing under that paragraph is excepted automatically.

A discharge ends personal liability. It does not remove a lien. The Supreme Court held in Johnson v. Home State Bank (1991) that a discharge extinguishes the action against the person while leaving the action against the property intact, so a judgment lien already fixed on a house (which some owners assume the LLC was formed to prevent, and which the LLC cannot touch once the owner has signed individually) remains a separate conversation. Chapter choice, exemptions and timing belong with bankruptcy counsel.

6. A Spouse Required to Sign May Have a Regulation B Argument

Federal Regulation B forbids a creditor to require a spouse's signature when the applicant qualifies alone, under 12 CFR 1002.7(d)(1), and where more support is needed the creditor may ask for a guarantor but may not insist that the spouse be the one. A spouse who signed only because the lender demanded it has the beginning of an argument.

The end of it is less settled. Courts are divided on whether a guarantor may raise the violation as a defense rather than as a separate claim, and SBA paper is the weakest ground of all: the SOP describes SBA's loan programs as special purpose credit programs under the Equal Credit Opportunity Act and requires a spouse's full guaranty when combined family ownership reaches 20 percent.

Which Route Belongs to Whom

Three of these six routes run through a lawyer's office, and an owner facing a guarantor suit or weighing a personal bankruptcy should start there. The other three, release on a payoff, release inside a settlement and a limited guarantee, are commercial bargains, though counsel should still read the paper on each. Delancey Street is a debt relief firm and not a law firm; it negotiates merchant cash advance, SBA and stacked business debt restructures, offers a free confidential review, and coordinates with independently licensed counsel when a matter needs legal work. In a negotiated settlement, the guarantor's release is a term to insist on from the first draft.

A guarantee is signed on the business's best day and read on its worst. Most of the exits were drawn on the first.