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What Businesses and Creditors Need to Know about Loan Guaranties

A loan guaranty is often needed in situations where a closely held corporation or LLC is borrowing money. Since such companies generally lack the collateral a bank wants to secure a loan, the bank requires an individual (usually a shareholder or member) to personally guarantee repayment of the loan in order to make the loan. Typically, a loan guaranty is signed at the same time as the loan documents. However, the guaranty may come after the loan is made in which case the parties must understand the challenges they face under New York law.

New York’s Statute of Frauds requires that a loan guaranty be in writing and signed. In addition, there must also be valid consideration for the guaranty (i.e., each party must receive some benefit in the contract). When a guaranty and loan are provided at the same time, the guaranty typically will meet these requirements as the guaranty is given in consideration for the loan.

Problems may arise when a loan guaranty is made after the loan was already given. These situations typically arise when the parties have taken a loan from an individual or entity other than a lending institution so there may not be appropriate documentation. Often, such guaranties occur orally – an individual (the guarantor) will assure a creditor that the loan will be paid by him/her in the event the debtor defaults. Such an oral promise may be enforceable, but it is very difficult to prove unless there is some written evidence of the agreement (even if the written evidence does not suffice under the Statute of Frauds). Evidence of oral discussions (known as parol evidence) can be offered to establish the validity and terms of the post-loan guaranty.

The most difficult hurdle to overcome in enforcing an oral loan guaranty is proving valid consideration. In order to have valid consideration for an oral guaranty, the creditor must establish 2 elements:

  1. The oral guaranty must directly benefit the promisor making the oral guaranty (not the original debtor), and
  2. The promisor must intend to establish for themselves an independent duty of payment irrespective of the liability of the original debtor. This is referred to as an “original” promise, as distinguished from a “collateral” promise in which the promisor is only liable if and when the debtor defaults (as in most guaranties).

Essentially, the debt must become the guarantor’s debt independent of the debt of the original debtor. As a result, an “oral guaranty” is to some degree a misnomer as it is not a guaranty of another’s debt (though it may superficially look like a one). In order to be enforceable, an oral guaranty involves the guarantor taking on a new obligation to the creditor, allowing the creditor to seek payment from the guarantor without waiting for the original debtor to default.

This means that if you are considering providing a loan guaranty after a loan has been given or you are a creditor who wants to accept a loan guaranty in such a situation, you must ensure the following:

  1. The guaranty is in writing
  2. There is clear and valid consideration for the guaranty that meets the 2 elements discussed above.

If the agreement doesn’t meet these requirements it may not be enforceable. If you are a guarantor or looking to enforce a loan or guaranty agreement, contact us to discuss your situation.

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