A Practical Guide On Who Must Guarantee A SBA 7(a) Loan

Lenders have discretion with respect to guaranties for commercial loans. However, all Small Business Administration (“SBA”) transactions must meet the minimum requirements set forth in SOP 50 10 5(J). The purpose of this article is to identify when an individual or entity must serve as a guarantor, as well as to outline when a lender may consider additional guaranties if there is a collateral shortfall. 

Overview

Any individual who owns 20% or more of a borrower must provide an unlimited full guaranty. In most circumstances, a loan must be guaranteed by at least one individual or entity. However, if an individual executes the note as a borrower in his/her individual capacity, he/she does not also have to execute a personal guaranty. If no one individual or entity owns 20% or more of the borrower, at least one of the owners must provide a full guaranty.

Example A: Borrowing Entity is owned by John (80%) and Jane (20%). John and Jane must each provide an unlimited full guaranty.

Example B: Borrowing Entity is owned by John (15%), Jane (15%), Jim (15%), Jill (15%), Joe (15%), Larry (15%), Lynn (10%). At least one of the owners must provide a full guaranty. The lender may require additional guaranties from the other individuals, despite their lower ownership interest(s), in its discretion and/or if any individuals are essential to business operations.

Example C: Borrowing Entity, a dental business, is owned by John (80%) and Jane (20%). John and Jane are named in the business acquisition purchase agreement and are signing the note in their individual capacity. John and Jane do not have to provide a full guaranty, as they are already fully liable for the note.

If the borrower is owned by a corporation, limited liability company, partnership, or other form of legal entity, the ownership interest of all individuals must be disclosed. When deemed necessary for credit or other reasons, the lender may require other appropriate individuals to provide full or limited guaranties of the loan without regard to the percentage of their ownership interest(s), if any.

Example D: John has no ownership interest in the Borrowing Entity. However, John is critical to the operation of the subject Borrowing Entity. Despite John’s lack of ownership, the lender may require John to provide a personal guaranty.

Secured v. Unsecured Guaranties

A guaranty may be secured or unsecured. If a loan is not fully collateralized by fixed assets, the lender must require the available equity in the personal real estate (residential and investment property) of the principals to be pledged to secure the guaranty up to the collateral shortfall. Liens on personal real estate may, but are not required to be, limited to the amount of the collateral shortfall. If there are tax implications with the lien amount in the particular state, the lender may limit the personal real estate lien to 150% of the equity in the collateral. However, this limitation is entirely up to the lender’s discretion and will vary depending on the specifics of the transactions and collateral shortfall, if any.

If both spouses own less than 20% of the Borrower, but their combined ownership is 20% or more, each spouse must personally guarantee the loan in full. If the spouse is a non-owner of the borrower, he/she must sign any appropriate collateral documents. For instance, the non-owner spouse’s guaranty secured by jointly held collateral will be limited to that spouse’s interest in the collateral.

Example A: Borrowing Entity is owned by John (15%), Jane (10%), and Jim (75%). John is married to Jane and Jim is John’s friend from college. John and Jane must guarantee the loan in full due to their spousal relationship and combined ownership of over 20%. Jim must also guarantee the loan due to his 75% interest.

Example B: Borrowing Entity is owned by John (90%) and Jim (10%). The particular loan has a collateral shortfall and the lender decides it will take a 2nd lien position on the personal real estate. John owns the personal residence with his spouse, Jane. Jane must serve as at least a limited guarantor to allow the lender to secure its junior lien on the real estate.

Entity and Trust Guaranties

All entities that own 20% or more of a borrower must provide an unlimited full guaranty. If the entity that owns 20% or more of the borrower is a trust (revocable or irrevocable), the trust must guarantee the loan with the trustee executing the guaranty on behalf of the trust and providing a certification of trustee. In addition, if the trust is revocable, the Trustor also must guarantee the loan. When deemed necessary for credit or other reasons, the lender may require other appropriate entities to provide full or limited guaranties of the loan without regard to the percentage of their ownership interests.

If an individual changed his/her ownership interest six months prior to the loan application, he/she would continue to be subject to the guaranty requirements set forth above. The only exception to the 6-month rule is when that Person completely divests their interest prior to the date of application.

Example A: Borrowing Entity was owned by John (80%) and Jane (20%) on January 1, 2018. On February 1, 2018, Jane reduces her ownership interest to 5% with John owning the remaining 95%. The Borrowing Entity obtains a loan commitment from the lender on March 1, 2018. Jane must provide a full guaranty.

Example B: Borrowing Entity was owned by John (80%) and Jane (20%) on January 1, 2018. On February 1, 2018, Jane fully relinquishes her ownership interest, leaving John as the sole shareholder. The Borrowing Entity obtains a loan commitment from the lender on March 1, 2018. Jane is not required to provide a full guaranty.

ESOP or 401(k) Ownership

When an ESOP or 401(k) owns 20% or more of a borrower, the plan or account cannot guarantee the loan. The plan or account must meet all applicable IRS, Treasury, and Department of Labor requirements. In addition, the following loan conditions must be met:

• The owner(s) of a 401(k) must provide his/her full unconditional personal guaranty. This guaranty must be a secured guaranty if required by SBA’s existing collateral policies.

• The members of the ESOP are not required to personally guarantee the debt. However, all owners of the borrower who hold an ownership interest outside the ESOP are subject to SBA’s personal guaranty requirements.

• The application cannot be structured as an EPC/OC. (13 CFR § 120.111(a)(6)). SBA regulations require each 20% or more owner of the EPC and each 20% or more owner of the OC to guarantee the loan, and the regulation does not provide for an exception.

Conclusion

There are specific circumstances when entities and/or individuals must provide guaranties. However, because each transaction is unique, lenders will apply a separate analysis to determine whether or not additional guaranties are required. Specifically, lenders will commonly require additional guaranties when there is a collateral shortfall, most commonly by way of limited guaranties secured by liens on personal real estate. Because all SBA loans must meet the minimum requirements of the SOP, it is important for lenders to have a firm understanding of when guaranties must be provided and when they are prudent based on the specifics of the transaction. For more information on guaranties or other commercial lending matters, send me an e-mail at soliver@lewiskappes.com.