Lenders and Borrowers Should Clearly Spell Out Extent of Liability Under Limited Guaranty
On occasion, a lender will agree to limit a guarantor’s liability under its guaranty to a fixed dollar amount that is less than the entire loan amount. In such a case, for example, the term sheet or loan commitment may provide that in connection with a $5 million loan the guarantor's liability will be limited to $2 million.
When we draft or review the guaranty agreement the first thing we ask our client -- the borrower or the lender -- is whether the intent was to limit the guarantor’s liability to $2 million in total or $2 million of the principal balance of the loan. If the limitation is only on the principal balance, the next question is whether the guarantor is liable for (i) all interest accruing under the loan or (ii) all interest accruing on the $2 million of principal that the guarantor is guaranteeing.
The third question we ask is about the costs of collection. Does the lender intend that the guarantor will be liable for all costs of collection in connection with pursuing a default by the borrower under the loan or only the costs of collection related to enforcing the guarantor's guaranty? If not clearly addressed, the guarantor often expects its liability to be limited to $2 million in total, principal, interests, and costs of collection.
There have been legal decisions in several courts attempting to interpret what was intended by provisions in guarantees that limit the guarantor's liability. Sometimes the decisions have been favorable to the lender and other times to the guarantor. In a recent case that came out of a Georgia federal court, a guarantor of two loans that totaled about $1.5 million signed guarantees that limited the guarantor's liability to about $105,000. In the promissory note there was a provision entitling the lender to collect attorney’s fees equal to 15% of the principal balance of the notes. Upon default, the guarantor was found to be liable for the $105,000 of principal under the note plus more than $66,000 in attorney's fees because the court did not find that the guaranty limited the guarantor's liability for anything other than the principal balance of the note.
Lesson to lenders and borrowers: make sure any limited guaranty, as well as any term sheet or loan commitment that precedes the limited guaranty, clearly states the extent of the liability of the guarantor for principal, interest, and costs of collection under the loan being guaranteed.
Larry Lerman is a commercial lending and real estate attorney at Lerch, Early & Brewer in Bethesda, Maryland who structures and documents complex commercial lending arrangements and represents parties who are buying, selling, leasing and financing commercial real estate. For more information about limited guarantees, contact Larry at (301) 657-0163 or email@example.com.