My name is Stephanie Harvey and I am a corporate/commercial lending lawyer with Gowling WLG. You are watching video three of our 'Types of Security' video series.
In this video we are going to address a topic we often receive questions about from our lender clients: namely the strategic use of Limited Recourse Guarantees and Limited Amount Guarantees to secure the repayment of loans.
Most of you will be familiar with the general concept of guarantees given in support of loan transactions. Whenever the asset base of a borrower or the strength of its covenant is felt by a lender to be insufficient to independently support a loan, the lender will look to a third party, known as the guarantor, to agree to pay the loan advances made to a borrower if the borrower should fail to repay those debts on its own.
The most common type of guarantee and the one most beneficial to the lender is an unlimited and unconditional guarantee. In that case, the liability of the guarantor extends to the full amount of the borrower's debts to the lender without any limit, and without any conditions being placed upon the lender calling upon the guarantor to make payment of those debts.
Typically it is fairly easy for a lender to obtain an unlimited and unconditional guarantee from a subsidiary of the borrower or the parent corporation of a borrower as they are all usually involved in the same lending arrangement as the members of a corporate group.
However, there are times when an individual person asked to provide a guarantee may be reluctant to take on that unlimited and unconditional burden. This is especially true if the prospective guarantor is a third party or family member with limited involvement in the business of the borrower.
Similarly, the principal shareholder of a borrower may be willing to provide a guarantee to show the lender that he or she is committed to the business and has some "skin in the game", but weary of providing an unlimited personal guarantee that could lead to personal bankruptcy if the business fails.
In other cases, a person may be willing to pledge a specific asset in support of a business, but not all of its assets. Thus, sometimes lenders need to have some flexibility and consider some alternatives to unlimited and unconditional guarantees to bring a loan transaction together.
One alternative type of guarantee is known as a Limited Guarantee or a Limited Amount Guarantee, where, as you might expect, the liability of the guarantor to the lender is limited to a fixed maximum amount. The limit can be expressed as a maximum principal amount with interest accruing after the date of demand for payment and any costs of enforcement added to the guaranteed amount, or the limit can be expressed as an "all-in" amount of the borrower's debts regardless of the component elements of that indebtedness.
Generally speaking, the limit can be tailored to the transaction, and be in whatever amount is needed to provide the lender with sufficient support to the borrower's repayment covenant.
Limited Amount Guarantees are ideally suited for individuals fully involved in a business who are asked to provide credit support. A limit of $1,000,000 may be sufficient to evidence the principal's commitment to the repayment of the borrower's loan.
Similarly a designated maximum limit will also be useful for a family member not involved in the business who is asked to provide credit support. The limit will give that guarantor comfort in knowing that his or her exposure is limited to a known amount regardless of what the borrower does in increasing the borrower's debt levels over time, and regardless of any poor judgment or bad decisions made in terms of running the borrower's business.
Without the limit being used, the prospective guarantor may refuse to provide a guarantee at all, and the loan transaction may never come to fruition.
Finally, even in the corporate context, a limit may be needed for a corporate guarantor to comply with certain negative covenants granted under its own loan arrangements where it has agreed not to provide a guarantee to any third party in excess of a stated threshold amount. In addition, if the prospective corporate guarantor's business is related to the borrower's business but only in a minor way, it will legitimately wish to cap its exposure and credit support.
The second alternative type of guarantee is known as a Limited Recourse Guarantee.
Typically, a Limited Recourse Guarantee is one where the lender's recourse against the guarantor is limited to realizing upon a particular target asset. Although the guarantee may be unlimited in terms of the amount of the borrower's indebtedness being guaranteed, the lender can only recover from the guarantor the amount realized upon the sale of the target asset.
The lender cannot commence an action against the limited recourse guarantor to recover any balance owing on the borrower's debts after the application of the realization proceeds of the target asset. Once again, the limit can be tailored to the transaction and apply to whatever target asset is available and is needed to provide sufficient support to the borrower's repayment covenant.
The most common use of a Limited Recourse Guarantee is in the context of a share pledge transaction. An individual or corporation related to the borrower is prepared to pledge their shares of the borrower in support of the loan, but unwilling to expose their other assets to the lender's realization remedies. In order to structure that pledge from a technical legal perspective, the guarantee is needed to create a debt owed by the limited recourse guarantor for which the share pledge is granted.
If after a default the shares are realized upon and sold by the lender, the lender cannot pursue the guarantor for any shortfall in the borrower's outstanding indebtedness.
Another use for a Limited Recourse Guarantee is in a situation where a specific piece of real property needed to support a loan is held by a corporation other than the borrower, and that corporation holds other real property or assets not intended to form part of the security package. A Limited Recourse Guarantee can be used to limit the related corporation's exposure to the lender on the borrower's loan to the target piece of real property. Once again, If after a default the target real property is realized upon and sold by the lender, the lender cannot pursue the guarantor for any shortfall in the borrower's outstanding indebtedness.
To recap the things we talked about in this session, a Limited Amount Guarantee restricts a guarantor's liability for the debts of a borrower to the lender to a specific amount regardless of the components of that indebtedness. On the other hand, a Limited Recourse Guarantee restricts a lender's recourse against the guarantor to realizing upon a particular target asset or assets. Although both of these specialty guarantees restrict the lender's rights and remedies in some fashion, they can be important tools to bring a loan transaction to completion when a requirement for an unlimited and unconditional guarantee cannot be granted for any reason.
If you have any questions about any of the points discussed or their application to a specific fact situation, please reach out to me or any member of our lending team.