Default on a Business Loan With a Personal Guarantee: 6 Ways the Lender Reaches the Owner

When a business defaults on a loan with a personal guarantee, the lender can reach out and try to collect it directly from the individual business owner. Think of a personal guarantee as an insurance policy taken out by the bank. If the business can’t pay back the loan, the guarantor is ultimately responsible for paying it back.

The personal guarantee gives the lender the ability to file a lawsuit directly against the owner, without filing a lawsuit against the business. This is particularly valuable if the business has already dissolved or is experiencing significant financial trouble, because you are still liable to repay the loan balance.

With an unlimited guarantee, the guarantor is responsible for the entire balance, fees, interest, and other costs incurred by the bank. With a limited guarantee, the guarantor agrees to a specific amount, which may be a percentage of the loan or a fixed dollar amount. The lender can recover the balance owed from any party to the loan: the business itself, you as the owner, or both. If there are other business partners who are also guarantors on the loan, the lender can seek repayment from any or all parties. The lender is not required to collect a specific amount from each individual guarantor.

If a lender takes you to court and is successful in winning a judgment, that gives them the right to levy your bank accounts. Levying means the lender can pull the balance owed directly out of your bank accounts, including your personal checking account and savings accounts. A judgment also gives the lender the right to put liens on property that you own. Assets the lender cannot reach are known as exempt assets. The details depend on the laws in your state. After all exemptions are applied, you’ll be left with your non-exempt assets. These are the assets the lender can seize to repay your debt.

In addition to levying bank accounts, the lender can also garnish, or take money out of your paycheck before you ever receive it. That money is then applied to your debt balance. Federal law sets limits on the amount of your income that a lender can garnish. Under those limits, the lender can take the lesser of 25% of your weekly disposable earnings or the amount of earnings that surpasses 30 times the federal minimum wage. If your state sets a lower limit, that applies instead.

SBA Loans

Under SBA rules, most SBA loans require a personal guarantee from all owners with 20% or greater equity in the business. If you take out a loan guaranteed by the SBA, that gives the government more power in collecting a debt from you. The government can garnish up to 15% of your disposable earnings without a court order. The government does have to give you at least 30 days advance written notice before they do so.

If the government doesn’t receive full payment on a debt after 180 days, that debt gets transferred to the Treasury for debt collection. Once the debt is with the Treasury, the government has the ability to garnish your future tax refunds or offset them. This means they will take the amount you owe and subtract it from any future tax refunds you are due to receive. At that point, the Treasury has several collection tools, and one of them is to garnish your Social Security check if you receive one. Government agencies are not allowed to take your entire Social Security check. The first $750 of your monthly payment is protected and cannot be garnished or seized by the government. No more than 15% of the benefit can be taken.

If you’re no longer with the company, it will likely come down to a question of how the agreement was written and what the exact terms were at the time. Even if you no longer have an ownership stake, the lender could still file a lawsuit to recover the loan balance from you.

If your business declares bankruptcy, this does not negate the personal guarantee. The lender can attempt to collect on the debt from you personally. You can, however, file for personal bankruptcy as an individual even after your business files for bankruptcy.

The lender can also report the loan to the three main credit reporting agencies. Once a debt shows up on your personal credit report, it can negatively impact your credit score and your ability to access credit for seven years. While the Fair Debt Collection Practices Act governs debt collectors, these protections don’t necessarily apply to business debt.

Get Out of a Personal Guarantee

It is difficult to get out of a personal guarantee in court. This is especially true if the personal guarantee was clear and unambiguous. The process of collecting on a personal guarantee typically begins with the lender sending demand letters and attempting to collect the debt. If they are not successful, they may proceed with filing a lawsuit. It may be possible to reach a settlement agreement or work out an alternative payment arrangement that satisfies the lender and prevents the lender from taking legal action against you. If the lender is willing to work with you, make sure you get the agreement in writing and that you understand your next steps.

If the lender agrees to write off part of the balance, then that debt is considered forgiven or canceled. If the lender forgives a debt, the lender must file a 1099-C with the IRS. For a lender to report forgiveness of debt, the amount canceled must be $600 or more. The 1099-C doesn’t mean that you owe tax on that full amount.

Ultimately, a personal guarantee does put your personal assets on the line. How a personal guarantee impacts you is largely based on your personal financial and legal situation. It’s important to consult a financial or legal professional before you take any action.