Personal Guarantees In Texas Real Estate

Introduction

Casual execution of a personal guaranty can end catastrophically for a real estate investor. Business lawyers who have practiced for any substantial time have stories of clients who were ruined by personal guarantees. A typical case is a physician-oriented real estate investment calling for an individual guaranty of multi-million-dollar development loan (for an apartment or strip center) even though the investor’s actual investment was much smaller. This firm has assisted many clients who have fled their state of origin (often California) in favor of Texas in order to sink their surviving assets into a protected Texas homestead.

So long as basic elements of validity are met, there is no real defense in Texas against a clear personal guarantee, at least in the absence of actual fraud. Moreover, a valid guarantee is easy to write. Large law firms are fond of writing guaranty agreements that go on for page after page, but the truth is that just a few core sentences usually do.

All of this makes it essential that a potential guarantor: (1) carefully examine the guaranty’s terms; (2) consult counsel before signing; and (3) when feasible, negotiate limitations on the guaranty’s scope, duration, and enforceability.

Applicable Law

There is no standard form of personal guaranty in Texas, so each guaranty is a custom contract between lender and guarantor. According to the Texas Supreme Court, a guaranty is a secondary contractual obligation on the part of a guarantor who promises to pay the primary obligation of another. Republic National Bank of Dallas v. Northwest National Bank of Fort Worth, 578 S.W.2d 109 (Tex. 1978).

The Statute of Frauds applies. A promise by one person (guarantor) to answer for the debt of another person (borrower)must be in writing and signed by the guarantor. Bus. & Com. Code Sec. 26.01(b)(2).

In order to recover in an action to enforce a guaranty agreement, the lender (or holder of the guaranty) must conclusively prove the following elements:

(1) existence and ownership of a written guaranty contract;

(2) performance of conditions precedent by the lender or holder of the guaranty;

(3) occurrence of the condition on which liability is based (borrower default); and

(4) failure or refusal of the guarantor to perform according to the terms of the guaranty. Barclay v. Waxahachie Bank & Trust Co., 568 S.W.2d 721, 723 (Tex.Civ. App.-Waco 1978, nowrit).

Unless they are ambiguous, Texas courts strictly enforce the terms of personal guarantees. Park Creek Assocs., Ltd. v. Walker, 754 S.W.2d 426 (Tex. App.—Dallas 1988).

Unless a guaranty is expressly stated to be irrevocable, a continuing guaranty can be revoked as to future indebtedness—but this requires written notice to the lender and existing advancements to the borrower remain guaranteed. Straus-Frank Co. v. Hughes (Tex. 1941).

For multiple guarantors, liability is usually joint and several with the primary borrower for the full amount of the debt.

Clauses Favorable to the Lender

Lenders want a personal guaranty to be as expansive and all-inclusive as possible. This is an example of a lender-oriented guaranty clause:

AS AN INDUCEMENT TO LENDER TO EXTEND AND/OR CONTINUE TO EXTEND CREDIT AND OTHER FINANCIAL ACCOMMODATIONS TO BORROWER, AND FOR OTHER CONSIDERATION AND VALUE RECEIVED, GUARANTOR UNCONDITIONALLY, ABSOLUTELY, AND IRREVOCABLY PERSONALLY AND INDIVIDUALLY GUARANTEES THE PROMPT AND FULL PAYMENT AND PERFORMANCE OF THE GUARANTEED INDEBTEDNESS (INCLUDING WITHOUT LIMITATION THE NOTE AND THE DEED OF TRUST) WHEN SAME FALLS DUE, IS REQUIRED, OR IS DECLARED BY LENDER TO BE DUE AND PERFORMABLE, AND AT ALL TIMES THEREAFTER. THIS GUARANTY IS AN INDEFINITE AND CONTINUING OBLIGATION OF GUARANTOR. THIS GUARANTY SHALL BE A CONTINUING OBLIGATION OF AND AGAINST GUARANTOR’S ESTATE IF GUARANTOR IS DECEASED.

GUARANTOR AGREES TO BE LIABLE, JOINTLY AND SEVERALLY, WITH BORROWER AND ANY OTHER GUARANTOR AS TO ALL OR ANY PART OF THE GUARANTEED INDEBTEDNESS AS WELL AS FULL PERMFORMANCE OF BORROWER’S OBLIGATIONS UNDER ALL LOAN DOCUMENTS (INCLUDING THE DEED OF TRUST).

IN THE EVENT OF A DEFAULT BY BORROWER IN THE PAYMENT OR PERFORMANCE OF ALL OR ANY PART OF THE GUARANTEED INDEBTEDNESS WHEN SUCH GUARANTEED INDEBTEDNESS BECOMES DUE (WHETHER BY ITS OWN TERMS, BY ACCELERATION, OR OTHERWISE) GUARANTOR SHALL, WITHOUT NOTICE FROM OR DEMAND BY LENDER, PROMPTLY PAY THE FULL AMOUNT DUE TO LENDER AND TENDER SUCH OTHER PERFORMANCE AS MAY BE REQUIRED BY THE LOAN DOCUMENTS.

THIS GUARANTY SHALL NOT BE IMPAIRED, BUT SHALL REMAIN IN FULL FORCE AND EFFECTNOTWITHSTANDING: (1) THE RENEWAL, EXTENSION, MODIFICATION, REARRANGEMENT, OR ALTERATION OF THE OBLIGATIONS OF BORROWER UNDER THE GUARANTEED INDEBTEDNESS; (2) THE INSOLVENCY, BANKRUPTCY, OR REORGANIZATION OF BORROWER, GUARANTOR, ANY OTHER GUARANTOR OF ALL OR ANY PART OF THE GUARANTEED INDEBTEDNESS; (3) THE UNENFORCEABILITY OF ALL OR ANY PART OF THE GUARANTEED INDEBTEDNESS AGAINST BORROWER BY REASON OF THE FACT THAT THE GUARANTEED INDEBTEDNESS EXCEEDS THE AMOUNT PERMITTED BY LAW; (4) THE ACT OF CREATING ALL OR ANY PART OF THE GUARANTEED INDEBTEDNESS IS OR WAS ULTRA VIRES; OR (4) THE MANAGERS, OFFICERS, PARTNERS, OR INDIVIDUALS CREATING ALL OR ANY PART OF THE GUARANTEED INDEBTEDNESS ACTED IN EXCESS OF THEIR AUTHORITY.

In addition, the lender may insist that the guarantor waive:

(1) formal notice, presentment, or demand before guarantor’s obligations are activated;

(2) any requirementthat the lender first file suit or obtain judgment against the borrower before making demand upon the guarantor;

(3) any requirement that the security property first be sold or foreclosed upon before activation of the guarantor’s obligations;

(4) defects or deficiencies in any of the loan documents;

(5) claims, defenses, or offsets for acts or omissions of the lender except in cases of willful misconduct or gross negligence; and

(6) any defense based on community property of the guarantor.

Clauses Favorable to the Guarantor

A sophisticated guarantor will seek limitations on the scope, duration, and enforceability of a personal guaranty. Such provisions may include:

(1) Notice to Guarantor of Borrower Default. Lenders want the guarantor to waive this but the guarantor should always insist on written notice from the lender in order to trigger the guaranty agreement’s obligations.

(2) Cap on Guaranty Amount. One of the best ways to limit the guarantor’s liability is to cap the total amount for which the guarantor is liable, regardless of events or circumstances.

(3) Maximum Duration of the Guaranty. Is there a good reason why a guarantor should remain liable for the entire life of the loan? Why not one year? Or three?

(4) Exception for Borrower Fraud or Misrepresentation. A guarantor should not want to find himself liable for the wrongful or illegal actions of the borrower, so it is important to negotiate so-called “bad boy carveouts.”

(5) Guarantor Payment Not a Default. Payment by Guarantor of any installment due under the Note should not, by itself, constitute a material default that permits Lender to declare default or accelerate the Note.

(6) Non-Recourse Clause. The guarantor can insist that a non-recourse clause be inserted in the note, indirectly limiting the guarantor’s liability.

(7) No Guaranty of Security Instrument Performance. The guarantor can limit his obligations to the financial obligations of the borrower under the note and disclaim any duties under the deed of trust.

(8) Exclusion of Exemplary Damages. The guarantor can decline to extend the scope of his guaranty to include any exemplary (punitive) damages awarded against the borrower by a court.

Guarantees of Hard-Money Loans

Hard-money loans should be based on the fundamentals of the deal itself. That’s what hard money means. The appraisal, down payment, and value of the security property should be all that matter. When it comes to hard-money loans, a sensible investor-borrower should not only refuse to sign a personal guaranty but should also insist on including a non-recourse clause in the note. If this is not feasible, the next best course of action is to limit potential damage by negotiating boundaries on the scope, duration, and enforceability of the guaranty.