KEEPING GOOD CUSTOMERS FROM GOING BAD WITH GUARANTEES
QUESTION: SINCE THIS CORONAVIRUS (COVID-19) PANDEMIC AROSE, I’VE BEEN HAVING A TERRIBLE TIME GETTING PAID BY SOME OF MY CUSTOMERS. COLLECTIONS HAVE SLOWED AND MAINTENANCE ISN’T BEING PERFORMED AS IT SHOULD BE. I EVEN HAD A PREVIOUSLY GOOD, LONGTIME CUSTOMER DESTROY A MACHINE A FEW WEEKS AGO AND TELL ME HE DOESN’T HAVE TO PAY ME BECAUSE ONLY HIS LIMITED LIABILITY COMPANY (LLC) IS LIABLE — NOT HIM — AND HIS LLC ONLY HAS ABOUT $1,500 WORTH OF ASSETS. OTHER CUSTOMERS ARE TELLING ME THEY MAY DECLARE BANKRUPTCY AS THEY DON’T HAVE ANY ASSETS LEFT. WHAT CAN I DO HERE?
Answer: If you didn’t have your customer or another party sign a guarantee, then depending on the circumstances surrounding the damage, your customer may well be right. Here is why:
Corporate shield of limited liability. Generally, absent criminal activity or commingling — mixing business and personal assets and activities — the owners of a corporation or limited liability company are entitled to rely on the existence of a corporate shield of limited liability when signing contracts. Corporations and limited liability companies are different types of business entities, but they both offer similar liability protections for their owners.
For most purposes, this means at least three things:
- The corporation or LLC shoulders the liability under all contracts the owner(s) sign(s) as the authorized signatory(ies) for that business entity
- The assets that can be made subject to a judgment are limited to the assets of the company in most cases.
- Neither the individual owner(s) of the company nor their personal assets will be subject to claims for debts of the company, including unpaid rent as well as amounts due for equipment damage.
This would be the starting point for most courts if the contract was signed on behalf of the corporation or LLC.
Customers who sign personal guarantees, and realize they’ve done so, tend to take better care of equipment with respect to which they’ve signed guarantees for the obvious reason that their personal assets are at stake.
Do not give up yet. Even if your contract was signed only by a corporation or LLC, you may still have a number of options:
- Insurance. If you required your customer to maintain property damage or inland marine insurance, consider submitting a claim on your customer’s policy. This is one of the better reasons for obtaining a Certificate of Insurance prior to commencement of the rental. The fact that the customer’s business entity has few assets will not impact the customer’s insurance coverage unless the policy has lapsed. In any event, be sure to advise your own insurer of the damage as soon as possible. Notice delays can result in claim denials. Also, if your own insurer ends up covering the loss, your insurer may well elect to subrogate — pursue the damage claim in your shoes — and seek recovery from the customer and/or the customer’s insurer.
- Liens. Many states now permit the filing of liens on real property that has been improved through the use of rented equipment. If you have not been paid, consider filing such a lien. Among other things, liens cloud titles to real estate and make life difficult for a number of upstream players, including owners and contractors who may be seeking to obtain financing, sell their projects and/or get paid. Be extremely mindful of timing here. Deadlines for lien filings vary from state to state, but virtually all lien deadlines are short and strictly enforced.
- Guarantees. Consider including a guarantee either in the body of your contract — preferably just above the signature line — or in a separately signed agreement. A properly written guarantee can make another person or entity, for example, the individual owner of your LLC customer and that owner’s personal assets, liable for your customer’s debts to you. Among other things, guarantees can be made for payment and/or performance and may be limited or unlimited, joint and several, conditional or unconditional, continuing, and binding upon any number of parties, including the individual owner(s) of your corporate customers and/or any one or more of their parent companies, affiliates, subsidiaries or even one or more third parties.
Also, depending on the circumstances surrounding the project, consider whether one or more of the following would be appropriate:
- Requiring a personal guarantee signed by the owner of your corporate/LLC customer. Guarantees signed by drivers, delivery personnel and other non-owners are usually unenforceable.
- Requiring a corporate guarantee signed by the general contractor.
- Requiring the individual owner(s) of the general contractor to sign a personal guarantee.
- Including reciprocal waivers of priority with respect to claims made against any one or more guarantor(s) so that no single guarantor would be able to claim that claims must first be made against any other guarantor(s).
- A strategic subordination of your customer’s other obligations owing to one or more of the other above referenced guarantors subordinating them to the customer’s obligations to you.
- A waiver of all setoffs, reductions and counterclaims by each guarantor, for example, claims that the equipment was defective or malfunctioned.
Obviously, demanding lengthy personal guarantees from your customers will not be practical in most cases, other than for large and/or complex projects. For that reason, sellers and lessors often opt for including an abbreviated personal guarantee in the signature line of a contract, which simply states that the signer personally guarantees the prompt payment and performance of the lessee’s obligations. Though not nearly as robust and easily enforced as a lengthier separate Guaranty Agreement, a signature-line guarantee still can be an immensely valuable motivator for an individual customer.
Be advised that not all customers will be willing to sign even a shortened guarantee. Representatives of large companies commonly refuse to sign them, as do some owners and representatives of smaller companies. For those parties, the choice will be between demanding a personal guarantee as a prerequisite for your agreement to conduct business with them or crossing out the guarantee and taking your chances by proceeding to do business with them. Also, as mentioned above, personal guarantees are rarely enforced against non-owners, such as drivers and delivery personnel. Nonetheless, including a signature-line guarantee remains among the best means of collecting the amounts owing under a contract, especially when customers fall on hard times.
When considering whether a personal guarantee might be helpful, keep one other issue in mind. During any rental term, the customer will be faced with a multitude of choices, including the job on which to use your equipment; which operator to assign to use your equipment, as well as that operator’s familiarity; how roughly or gently to treat your equipment; how closely to monitor, service and maintain your equipment; and how carefully to protect your equipment off-hours, at night, during transportation, and/or in the event of a storm or other emergency.
Customers who sign personal guarantees, and realize they’ve done so, tend to take better care of equipment with respect to which they’ve signed guarantees for the obvious reason that their personal assets are at stake. Among other things, this tends to yield reduced wear and tear, fewer accidents, lower cleaning and maintenance costs, and most importantly, enhanced collections for rental operators.
In the final analysis, guarantees are some of the most effective, but commonly overlooked, means of enforcing contracts and creating proper motivations for customers. Consequently, lessors who make a habit of obtaining personal guarantees from their customers tend to spend more time making money and less time trying to collect it
For more on this topic, the August 2019 issue of Rental Management includes the Legally Speaking article “Peace through strength and getting people to see things your way.” The article deals in broad terms with the same issues described, including the need for a guarantee. Click here to view the article.