One of the differences I had to get accustomed to when I came to credit union land were requirements for guarantors. On the banking side of the fence, guarantees were not a regulatory issue. Oh, we almost always got them and the only way we would look at a deal non-recourse would be if it went to the secondary market or if we received other concessions to entice us to not require a guarantor on a loan. Another time we would look at non-recourse lending was if we had a project that had very strong cash flow that would exceed the loan term or amortization.
At that time in my career, guarantees on a loan seemed more common loan sense than a matter of regulation. Credit union regulations have a clearly defined set of requirements for loan guarantees. These are required, unless you have other guarantee stipulations with certain government guaranteed loans. Section 723.7(b) states principals, other than those in a not-for-profit organization as defined by the IRS Code or where the Regional Director grants a waiver, must provide personal liability guarantees for the commercial loan. Some have read this to mean that any natural person with ownership in a company, no matter how small that ownership portion may be, must provide a personal guarantee.
But a reading of that one sentence in the regulation and guidance, without an understanding of the whole regulation is “lucky-dipping”. This is a Missouri term we used to use when someone picks out one sentence or item in a much larger document and bases an opinion on that one item, even though it may contradict the whole. Whatever you come up by sticking your hand at the bottom of the lake, no matter if it a catfish or a handful of mud, you cannot assume the entire lake consists of whatever you pull up.
A Supervisory Letter titled, Evaluation Credit Union Requests for Waivers of Provisions in NCUA Rules and Regulations Part 723, Member Busienss Loans (MBLs) provides further clarity on the subject. In reading on page 10 of that document the definition of who has to guarantee is outlined as “one or more natural persons who have a majority ownership interest in the business organization (borrower) receiving the loan. For a corporation, this will be one or more shareholders having a majority ownership of the organization. Natural person partners having a majority ownership in the partnership must each guarantee the full amount of a loan to a partnership.”
The next key is to define what is a majority? This is necessary to find out who will have to guarantee. Majority is a majority of all classes of ownership. This could be general and limited partners in a partnership, or common and preferred stockholders in a corporation. So you have to have at least 50.1% of the people in ownership provide a full guarantee on the loan. This can get more complicated if a part of your ownership group is a company or a series of nested entities. Then you need to drill down through the different layers of ownership in the company to determine exactly who will need to provide a personal guarantee. Also you should be getting corporate guarantees for each level of ownership as well. Page 11 of the document is a wonderful resource and provides an example in a chart of who and what entities need to sign.
I would add that as a practical matter, even if the controlling partner or stockholder has a minority ownership percentage, the officer should get the guarantee from that person. It only make sense to have guarantees from those that control the entity. Another idea is to get a guarantee from anyone who has 20%+ ownership; this follows rules found with the SBA and Rural Development. A final practical idea here I will advance is to get the guarantee of those strongest financially, even if they have a minority of ownership. At the end of the day, you want your loan to be paid.
In the next post, I will look at more guarantor issues.