Business owners are often asked to sign personal guaranties in connection with obligations of the company. At times they are non-negotiable components of important transactions that have great value to the business, such as obtaining a loan, or purchasing inventory on credit.
When the business has multiple owners and each one is a guarantor, the guaranties are typically “joint and several”, where a default by the business permits the creditor to go after any guarantor for the full amount owed. One guarantor can be stuck with the entire obligation if the creditor chooses. The other owners get away scott free, unless they previously entered into an agreement that requires shared responsibility for personal guaranties.
Shared responsibility takes the form of a “Right of Contribution” in the company’s Shareholders’ Agreement. It provides that if one owner is forced to pay out of pocket above his or her percentage interest in the company, the other owners must reimburse by contributing according to their respective percentage interests. The reimbursement is made to the paying owner, not the creditor. The end result is that each owner contributes an amount proportional to his or her percentage in the company, regardless of how the creditor chose to collect from the guarantors.
Without a Right of Contribution, the disproportionately targeted owner has no recourse against the other owners. While a Right of Contribution does not help a guarantor defend against the creditor, and it is only collectible to the extent the other owners have available assets, it is a valuable tool to promote shared responsibility in the face of a potentially devastating situation.