"How could they get my personal bank account?" Kelly from Super Electrical Subcontractor asked me desperately.
She was checking out at a grocery store when her card was declined. After she embarrassedly left the grocery store, she called her bank to find out what was going on. She knew she had plenty of money in that account. The only thing her bank could tell her was that all of her accounts had been garnished (frozen) by Sunset General Contractors.
Kelly recognized the name—a company she had only done business with once about a year ago. In fact, they still owed her money for that project. She called me in a panic to figure out what was going on. After some research, I discovered that Super Electrical Subcontractor and Kelly individually were sued by Sunset General Contractor. Kelly had never received notice of the lawsuit because it was served through her address listed on the Texas Secretary of State, which was an old address. If you do not answer a lawsuit, even if you are unaware of it, a judgment can still be taken against you. Sunset General Contractor was able to get a judgment against Kelly individually, even though she should have been protected from any liability of Super Electrical Subcontractor because it was a company. Kelly had signed a personal guarantee as part of her subcontract and agreed to be personally liable for the debts of her company.
What's a Personal Guarantee?
Signing a personal guarantee means that if your business becomes unable to repay any debt, you, as an individual, assume personal responsibility for the balance. That means judgments can be made against your personal bank accounts and assets, like we saw with Kelly.
In my experience, a general contractor that asks you to sign a personal guarantee as part of a subcontract is "sucker fishing," meaning they do not actually expect you to sign it. They expect you either to say that you will not sign it or to send the subcontract back and sign everything but the personal guarantee. If you do sign the personal guarantee, however, it's a win for them. They will gladly accept it and use it against you.
The initial subcontract that the general contractor sends over is just their first offer. If you agree to everything, it's like paying the sticker price for a new car. Everyone knows the dealer will take less than the sticker price, and they expect you to negotiate. It's the same with a subcontract. The general contractor expects negotiations; it shows that you are informed and paying attention.
Although slightly different, subcontractor bonds (which we covered in Chapter 3) are another form of personally guaranteeing your performance of a subcontract. When you sign personal guarantee paperwork with a bond company, the bond company then issues the general contractor a guarantee that you will complete the contract and pay everyone you hire. If you fail to perform, the bond company will pay the claim and then come after you for reimbursement. Unlike the personal guarantee that you sign in a subcontract, if the general contractor wants to recover funds from you personally, they have to sue you, and if you don't have the funds or you file bankruptcy, they will not get any money. The bond gives the general contractor faster and guaranteed payment if you default.
Being incorporated means you have filed paperwork with the Texas Secretary of State and your company is legally recognized as one of the following entities: a corporation, a limited liability company, a limited liability partnership, a limited partnership, or a professional corporation.
Which type of entity you choose will depend on the tax liability and the purpose of your business. Once you are incorporated, your business becomes its own entity and will need its own bank account that only business funds run through. You will become an employee of your company. It is vitally important that you keep the company's business separate from your individual income and expenses. If you do not treat your company as a separate entity, the law won't either. Using your company assets and accounts for personal expenses could lead to personal liability.
Make sure the address you have on file with the Secretary of State is up to date. Legal notices regarding your business will be sent to the address they have on file. You will be considered to have received such notices once they are sent to that address even if you don't actually receive the notice.
Why You Should Incorporate
Treating your company as its own entity is important because of the protection it provides. Any debts or wrongdoing of the company can only be held against the company. For example, if your company signs a contract with an IT company for one year's worth of service, but after six months you switch companies, the first IT company can sue your company for the remaining six months left on the contract you canceled. Any lawsuit or resulting judgment would only be against the company, not you as an individual, meaning your personal accounts and assets will not be subject to collection of the IT company's judgment, but your company's assets would be.
When it comes to incorporating, there are a few important things to keep in mind.
Filing a DBA, which stands for Doing Business As, is not the same thing as incorporating. A DBA only describes a person doing business as a company name—for example, Josh Bacon DBA The Sprinkler Guys. A DBA provides no protection, even if you file an assumed name record with the county clerk. It is the same as just doing business individually.
If you sign a personal guarantee, you are waiving the protection you have because of your incorporated entity. You are agreeing to be personally liable for the debts of your company. You are agreeing that your personal assets will be available to satisfy the debts of your company.
I cannot repeat this enough: do not sign a personal guarantee as part of a subcontract.
Now, there are times when you have to sign a personal guarantee, like when you are buying property for your company, or if you are buying a vehicle or equipment for your business. In those circumstances, it is normal to sign a personal guarantee because you usually cannot negotiate the terms of a loan agreement with a bank for vehicles, equipment, or property. Do not, however, sign a personal guarantee as part of a subcontract; do not put up your personal assets in order to work on a construction project. Because it is not legally required, you can negotiate the terms of the subcontract to exclude the personal guarantee.
Whenever you sign any document on behalf of your incorporated company, make sure you sign your name and title in the company. For example, I always sign Karalynn Cromeens, Member, The Cromeens Law Firm, PLLC. When signing a company document with just your individual name, it can be argued that you signed in your personal capacity, and you are personally liable.
Provision Language Examples
Here is one example of what a personal guarantee looks like:
AGREEMENT
In consideration of the Recitals, the covenants set forth herein and other good and valuable consideration the receipt and sufficiency of which are hereby acknowledged, and as an inducement to General Contractor to enter into the Agreement with Subcontractor, Guarantors hereby agree and acknowledge as follow:
Guarantors hereby unconditionally and irrevocably guarantee to General Contractor the due and punctual performance by Subcontractor of its obligation to fully and promptly pay all employees, agents, subcontractors, material supplier and labor suppliers of Subcontractor, to the same extent and effect as if Guarantors were the Subcontractor under the Agreement.
The parties comprising Guarantors shall have joint and several liabilities for the duties, liabilities, obligations and indebtedness of Guarantors under this Guarantee.
Guarantors agree to be bound by the provisions of the Agreement.
Here is another example:
I, _______ (name), residing at________________ (address)
Personally guarantee to you the payment of any obligation of the Company, and I hereby agree to bind myself to pay you on demand any sum, which may become due to you by the Company whenever the Company shall fail to pay the same. It is understood that this guaranty shall be a continuing and irrevocable guarantee and indemnity to such indebtedness of the Company. I do hereby waive notice of default, nonpayment and notice thereof and consent to any modification or renewal of the credit agreement hereby guaranteed.
Because Kelly wasn't aware of the lawsuit against her and thus didn't respond, her company Super Electrical Subcontractor was never able to collect the money they were initially owed by Sunset General Contractor. And because Kelly signed a personal guarantee, Sunset General Contractor successfully and legally collected its $5,000 judgment from her personal bank account. Even though Super Electrical Subcontractor was incorporated, when Kelly signed a personal guarantee as part of the subcontract, she waived the protections offered by incorporation and became personally liable for the debts of her company.
In the next chapter, I'll show you how to protect yourself from being responsible for the work from other subcontractors, and I'll explain why physically visiting a project site is a must.
Key Points
- Do not sign a personal guarantee as part of a subcontract.
- If you are not incorporated, go get incorporated.
- Make sure you run your company as its own entity.
- When you sign a document for your company, make sure you use your name and title.
- If you sign a personal guarantee, you are waiving the protection you have because of your incorporated entity.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.