One of the items that I have spent a lot of time dealing with in the past month is the issue of defaulting on business loans and what that means in Alabama and how that can impact your personal financial situation.
Of course, we hope that you never have an issue of missing payments or struggling with any of your debt service. But, as your lawyer, it is my job to prepare you for that situation and help you navigate it in the best possible way for you.
To begin, that requires a certain understanding of the rights available to banks with regard to your deposit accounts. I covered this in the Legal to English Newsletter last week. But, for you, I want to dive a little bit deeper.
Bank Rights with Deposit Accounts
Your checking account, in the deposit agreement, grants your bank the right to set-off (take) any money you have on deposit against any money you owe. This, of course, is only true if you have money on deposit and you owe the bank money.
Though this is rarely used. In business, there are times this can be problematic for you. That can come when the business is having a difficult time, or when you have determined it is best to shut down. Though we hope that never happens, you need to understand what is going on and how it can impact decisions you need to make.
One of the reasons we talk about the legal protections for your business is to help protect your personal assets from being used to satisfy your business debts. If you are not careful, this right of set-off held by your bank can create quite a problem for your business and you personally.
How Business Loans Impact You Personally
Most bank loans today require a personal guarantee of the owners. The set-off right extends to any debt over which you have responsibility. That means, if you have money on deposit in your personal deposit account and your business loan goes into default, your personal deposits may be at risk for set-off because of your personal guarantee. Also, there is often no notice requirement. That means, you will not receive any warning before your personal assets are seized to collect on your business debts.
The real reason I want to talk about this today, is because most of the time your bank is getting you to personally guarantee your business loans based on the way you sign the agreement, and I want to help you prevent it or at least help you understand what is going on.
Automatic Personal Guarantee
A personal guarantee is a guarantee by an individual to satisfy any unpaid debt of another person or entity. That means, if you personally guarantee the debts of your business, you are not shielded from the liability of unpaid debt. It is one place where your entity cannot protect you. If you agree to waive the right by agreeing to personally guarantee a debt.
In Alabama, if you do not sign a loan document correctly (as an officer of the company), you will run the risk of, unintentionally, creating a personal guarantee on any Corporate Loan Documents you sign. If you do not clearly indicate that you are signing as an officer of the company, you may have signed personally AND as an officer of the company. On top of that, in most Corporate Loan Documents, there will be a personal guarantee of the signatory for the company included, no matter how you sign it.
In Alabama, this is binding. Unless you make it clear it is not. You want to make sure you understand your obligations under the terms of any loan agreement. The reality is, you don’t have much of a choice. If you want to borrow money from your bank, you will sign the agreement they want you to sign. But, it wouldn’t hurt to ask the question. Or at least understand what you are agreeing to.
So, Why Am I Telling You This?
I want to make sure you fully understand what you are getting into when you choose to borrow money for your business. It is too easy to simply borrow money for your business when you need it without considering the consequences it may have on you personally.
What I am saying is: Read your documents carefully to make sure you understand exactly what you are signing. Better yet, send them to me before you sign them. At least then, you will understand what is going on!
Understanding Your Rights
I explain the personal guarantee elements and the set-off rights of a bank to make sure you fully understand what is at stake if you sign a loan document with a personal guarantee and, for some reason, your business becomes unable to pay any of your debts. Though a simple solution would be to ensure that your deposit accounts and your loans are not in the same institution, this is not always possible. After all, if you need the loan, you often receive a benefit for having your deposits at the same place as your loans. Sometimes, there are even benefits for your personal accounts. This is fine. It is helpful in business and it may keep things simple and easier to operate your business. It is the best way for things to work. Of course, you never plan to default on your loans. I am simply giving you this information to hold in your back pocket. In case there is ever a problem.
The real point here, as I say so often is, make sure you read your documents before you sign them. Remember contracts describe your agreement. Importantly, they outline what will happen if things don’t go according to plan. In the banking world, this is something to keep in mind.
Make sure you consider your personal banking relationship and how it relates to your business relationship. You don’t need to do anything now. Hopefully, it will never matter. But, if it ever does. Make sure you don’t make it easier than it needs to be. Much of protecting yourself is in understanding what can happen and to make sure you know how to proceed if things do not go according to plan.