Personal Guarantees In Texas Real Estate

Topics Covered

No Standard Guaranty Form
Law Applicable to Guarantees
Guaranty Clauses and Provisions
Guarantees of Hard-Money Loans

The Real Risk of a Guaranty

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-dollardevelopment 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 paragraphs will do.

No Standard Form

There is no standard form of personal guaranty in Texas, so each guaranty agreement is a custom contract between lender and guarantor. It is important to understand that the personal guaranty of a loan is neither standard nor required, although lenders will try to convince borrowers that this is the case (“It’s part of our standard loan document package.”). A guaranty is an optional add-on designed to over-collateralize the loan and reduce the prospect of future loss by the lender. However, a borrower or potential guarantor can simply refuse. This author has known several wealthy real estate investors who have never signed a personal guaranty and, as a matter of personal policy, never will. And yet they have borrowed millions of dollars in their careers.

Even if the decision to sign a personal guaranty is made, it is advisable for a potential guarantor to: (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

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).

Guaranties are to be strictly construed according to their precise terms and must not extend the guarantor’s obligations beyond the language of the guaranty agreement. BBVA USA v. Francis, 642 S.W. 3d 932 (Tex.App.—Houston [14th Dist.] 2022, no pet.).

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, enduring, and all-inclusive as possible. This is an example of a basic lender-oriented guaranty:

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 AS THEY MAY BE AMENDED OR MODIFIED) 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 GUARANTORAND AGAINST GUARANTOR’S ESTATE IF GUARANTOR IS DECEASED.

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

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

(2) any requirement that 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

(9) 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

In any transaction where a personal guaranty is requested, a primary borrower question should be “Is this really necessary?” Hard-money loans are an example where they usually are not. Hard-money loans are (or should be) based on the objective and verifiable fundamentals of the deal itself. That’s what hard money means. The down payment, appraisal, and the security property should be all that matter. Even the borrower’s credit can be considered somewhat irrelevant.

In most hard-money cases, the borrower should not only refuse to sign a personal guaranty but should also insist on including a non-recourse clause in the note (no collateral subject to the security interest beyond the subject property). If avoiding a personal guaranty is not feasible, the next best course of action is to limit potential exposure by negotiating boundaries on the scope, duration, and enforceability of the guaranty.