If you are a real estate investor, nonperforming loan investor, or private lender, you’ve undoubtedly had or considered doing a deal or two with a partner. Working with other stakeholders in a deal or venture is dicey at best, particularly when the venture takes on debt that is personally guaranteed by the partners. Taking on recourse debt (where the debt is personally guaranteed by the owners of the business) brings us to a term that you will hear in such a situation…Joint and Severable Liability.
In a business loan where the business entity is the borrower, it is more common than not that the lender requires the owners of the entity to be “guarantors” on the loan. If the business entity fails to perform, the lender then has the right to go after the guarantors for payment. The degree of such liability of each guarantor varies from loan to loan, but most lenders require joint and severable liability. That term essentially means that each guarantor is on the hood for 100% of the debt.
For example, let’s say that four partners had a stake in a building in which they borrowed $100,000 with each signing a personal guaranty that was “joint and severable.” One would think that, in the case of a default, that each guarantor was on the hook for their share of the $100,000, in this case 25% or $25,000. That assumption would be wrong. Each partner in a joint and severable liability loan would be on the hook for the entire $100,000! Let’s say that three of the partners filed bankruptcy after the default. The lender would be well within their rights to go after the fourth partner for the full amount as they had joint and severable liability.
There are, however, instances where the lender is willing to limit the liability of each guarantor, but the lenders usually require that at least 150% of the loan amount is assigned in liability to the group. In our above scenario, the lender would want guarantees up to $150,000 (150% of $100,000), or $37,500 per person. Of course, the liability can be laid out in any way that the lender will accept and write into the loan documents, but usually you will see joint and severable liability with the majority of recourse loans.