June 3, 2013
Sometimes the only way to persuade another party to enter into a contract is too guaranty that the amount owed will be paid by a third party in the event that you cannot completely pay the amount owed. This provides an extra layer of protection to the non-guarantying party as the guarantying party becomes responsible for any amount owed that is not satisfied. The Personal Guaranty / Guarantee Agreement and its language in the agreement will determine the terms of this deal and when the guaranty to pay by the third party will activate.
A Guarantor, is the party guarantying that the consideration or amount owed will be satisfied; a Guarantee is the party to whom such guaranty is made. For example, with respect to student loans, parents may act as a Guarantor and guaranty that the student loans their child is borrowing will be repaid to the Guarantee organization, such as Sallie Mae, whom loaned the money to their child.
In many business, financial, and commercial contracts, you many times run into guaranty language, either embedded within a contract or as a wholly separate contract attached as an exhibit or addendum that guaranties part or all of a larger agreement. In a typical business contract, two businesses will contract in a way that Business A agrees to pay Business B an agreed upon amount for the agreed upon good(s) or service(s). However, in some transactions, such as a commercial lease, commercial loan agreement, or other payment overtime agreement, one of the businesses may want the other business’ owner(s) to sign a guaranty. Ultimately, this guaranty requires payment by the individual(s) who made the guaranty in the event of a default of payment by the business.
Guaranty clauses or agreements can be drafted very conservatively or extremely aggressively. For example, many business guaranty agreements have language that in the event of default of payment do not require the Guarantee to exhaust all remedies against a business Guarantor, including even filing a lawsuit against the business Guarantor, before enforcing the guaranty and demanding payment from the individual(s) who executed the guaranty. As a result, in a breach of contract case, it is common practice for attorneys representing a business Guarantee to sue both the other business and the individual Guarantor(s) who signed the guaranty at the same time as opposed to separate or subsequent lawsuits. This is why it is extremely important that the drafter or the reviewer or negotiator of a guaranty provision or agreement understand when the obligations of a Guarantor are triggered. A poorly negotiated guaranty provision or agreement could put individual third parties at unnecessary or excessive risk.
As noted above, guaranty language can either be embedded within an overall contract as one or more provisions or clauses, or rather such language can be drafted into its own, wholly separate contract attached as an exhibit or addendum to a larger agreement. In Virginia, as in many jurisdictions, a guaranty is often considered a separate agreement between two or more parties. A very simple and well-articulated opinion outlining this concept, written by Judge James Chamblin, can be found in the 1989 Loudon County case Snyder v. Keller, 12132., 1989 WL 646376 (Va. Cir. Ct. Sept. 13, 1989). As this opinion explains, Virginia guaranty agreements must be in writing and signed by the guarantor. This opinion is also the likely result of why many organizations use a separate document, or contract, for the guaranty as opposed to simply including guaranty language in a single overall document.
As a result of the common practice of using separate documents, it is that much more important for drafters and reviewers / negotiators to ensure that the language in both documents is consistent. There have been interesting Virginia Supreme Court cases that highlight the pitfalls of document inconsistency and its unintended consequences. Such unintended consequences give way to exploitation by clever litigators, which only heightens the need for quality contract drafting. Use of separate documents also gives way to the importance of proper use of specific terminology and contract language, such as “attached hereto, incorporated herein, and made a part hereof” language, but that is the topic of another day and another article.