For many community banks, the legal side of banking can be overwhelming and difficult to navigate. At ICBB, we hope to be a resource for community banks in all aspects of their operations. We’ve asked our friends at Dinsmore & Shohl LLP to provide information on legal subjects within banking.
DISCLAIMER: The information contained in this article is provided for informational purposes only and should not be construed as legal advice on the subject matter.
As legal professionals, we are often asked by commercial lenders which is more advantageous: to list business owners as co-borrowers, or as guarantors. In many cases, listing the owners as guarantors can be advantageous. But what does that entail? In this article, we will (1) recap the requirements for the Kentucky Guaranty; (2) consider the Equal Credit Opportunity Act; (3) discuss the importance of reading and understanding the financial statement provided by a guarantor; and (4) highlight the strategic benefits of the guaranty in a workout or foreclosure situation.
Kentucky Requirements
Each state has its own guaranty requirements. In Kentucky, a guaranty is valid and enforceable if it:
- is in writing;
- expressly refers to the instrument or instruments being guaranteed;
- contains provision specifying the amount of the maximum aggregate liability of the guarantor; and
- contains the date the guaranty terminates.
In addition, system generated guarantees typically include a waiver of claims, which provide significant strategic benefit for the bank.
The Spousal Requirement under the Equal Credit Opportunity Act
A friendly reminder about the spousal requirements of Regulation B of the Equal Credit Opportunity Act: 2 the bank cannot require the spouse of the borrower’s owner to personally guaranty the debt of the company simply because that individual is the spouse of the owner. However, the bank may obtain from the spouse a limited guaranty of their interest in any jointly owned property included in the financial statement provided by the guarantor to the bank. Compliance with the requirement is tricky. It is recommended that the bank work with outside counsel to accomplish.
Financial Statements
It is important that before obtaining a guaranty, the bank obtain a financial statement from the proposed guarantor that lists the guarantor’s assets and liabilities. The financial statement should include a verification that the information is true and accurate and that the guarantor understand that the bank is relying on same to make the loan. In addition, the bank should require the guarantor to update their financial statements annually. A bank should review the financial statement provided and confirm the following:
- how the assets are owned:
- with the guarantor’s spouse;
- as tenants in the entirety;
- by an affiliated entity; and
- what is owed against it.
If there are assets listed on the financial statement that are owned jointly with someone not guaranteeing the debt or as tenants in the entirety, the bank should obtain the joint owners agreement, encumbering their interest or the bank should understand that it will not be able to reach those assets in the event it has to pursue collection on the guaranty. Finally, in the event of a bankruptcy filing, to the extent guarantor made false representations in their financial statements, they can be used to argue the debt is not dischargeable in bankruptcy.
Foreclosure
1 KRS § 371.065
2 15 USC § 1691
While typically viewed as a secondary source of repayment, there are strategic benefits to guaranties in a workout or foreclosure situation. When the guarantor is the owner of the borrower, the personal guarantee encourages the borrower to ensure the loan is paid and discourages the owner from siphoning cash and assets from the borrower because the bank can simply pursue the guarantor. In situations where the borrower is uncooperative or has asserted counter-claims in the foreclosure action (and assuming the guaranty includes the waiver), the bank can pursue judgment against the guarantor on the basis that the guarantor waived all claims and defenses. Once the judgment is obtained, the bank can start applying pressure to the guarantor (who owns the company) by collecting on the judgment with the hope that it forces the borrower to resolve the litigation.
Obtaining a guaranty can have strategic benefits in many instances, but several requirements must be met. We hope this article provided a quick refresher on personal guaranties for community banks.
Getting the right support from a correspondent banking institution can also serve as a strategic advantage for your community bank. Independent Community Banker’s Bank has established a reputation for excellence over the last 30 years. ICBB serves Community Bank’s throughout Illinois, Indiana, Ohio, Kentucky, West Virginia, and Tennessee to better serve their customers using a variety of services, including credit card solutions and loan participations. To learn more about how we can assist your bank visit www.icbb.bank or contact our Account Executive team solutions@icbb.bank.