Commercial loans frequently require the personal guaranty of some or all of the borrower’s principals. Recently, there has been a move toward distinguishing between a “springing” and an “exploding” guaranty. Both lenders and borrowers should recognize the differences between these two types of guaranties.
An exploding guaranty is the type customarily used in commercial loan transactions. An exploding guaranty becomes effective on the date the guaranty is signed ─ frequently, the date of the initial closing of the loan, but it can be later, such as upon an extension or modification of the loan. The guaranty terminates upon a stated condition or upon the repayment in full of all of the borrower’s obligations under the loan agreement.
A springing guaranty differs from an exploding guaranty in that it becomes effective upon the occurrence of a particular event after closing, such as the borrower’s bankruptcy, failure to pay real estate taxes, or the filing of a foreclosure against the real estate. In other respects — such as the termination of the guaranty — springing guaranties operate like exploding guaranties.
There are several issues to consider when a borrower is presented with a form of guaranty by a lender or the borrower’s lawyer suggests to the lender that the guaranty take the form of a springing vs. an exploding guaranty. Among the issues to be considered are:
● When does the guarantor’s liability begin?
● What is the enforceability of the guaranty in the event of the guarantor’s bankruptcy?
● What is the effect on the guaranty if the loan is subsequently modified?
● How must the guarantor treat the guaranty on its balance sheet?
● Is there adequate legal consideration for the guaranty?
These issues can have a significant effect on the relative rights of lenders and guarantors. If you have any questions with respect to the use of particular forms of guaranties in loan transactions, please do not hesitate to telephone us.