A guaranty is a separate agreement under which a person or entity other than the borrower, the guarantor, promises the lender to pay or perform the borrower’s obligations if the borrower does not. On a commercial real estate loan it is the source of the lender’s recourse beyond the property, and its scope is set by its own document.
Who is the guarantor, and why does the lender require one?
The borrower on a CRE loan is a single-purpose entity that owns the property and nothing else. The guarantor is the sponsor’s principal, a parent entity or a fund with a balance sheet the lender can reach, and the lender underwrites that balance sheet beside the property.
The guaranty is signed by the guarantor, not the borrower, and it stands on its own. It survives until the lender releases it in writing.
What types of guaranty appear on CRE loans?
| Type | What the guarantor owes | When it ends |
|---|---|---|
| Payment (repayment) guaranty | The debt, in full or up to a percentage or fixed amount | Repayment, or burndown to a stated level |
| Completion guaranty | Completion of the project on budget and free of liens, and the cost to finish it if the borrower stops | Completion, evidenced and confirmed |
| Carry guaranty | Interest, taxes, insurance and operating shortfalls until the property stabilizes | Stabilization on the lender’s definition |
| Carve-out (non-recourse) guaranty | The lender’s loss from specified bad acts, and the whole loan on a full recourse trigger | Repayment; it does not burn down |
A full or partial payment guaranty is what makes a loan a recourse loan. A carve-out guaranty is what sits under every non-recourse loan: the guarantor owes nothing on the debt unless the borrower commits an act on the carve-out list, such as fraud, misapplication of funds, waste, a voluntary bankruptcy or an unauthorized transfer. Construction loans commonly stack a completion guaranty, a carry guaranty and a repayment guaranty on the same guarantor.
What financial covenants and reporting does a guaranty carry?
A guaranty carries guarantor financial covenants: a minimum net worth, a minimum liquidity, and sometimes a limit on contingent liabilities, tested against the guarantor’s financial statements annually or quarterly. A breach is a loan default even when the property is performing.
The reporting obligations run with the covenants. The guarantor delivers a personal or entity financial statement, tax returns and a schedule of real estate owned within a stated number of days after each year end. Each lender defines net worth and liquidity its own way, so a guarantor with loans at several lenders is tested on several definitions at once, and the most restrictive one sets the floor the guarantor operates to.
How do burndown and release provisions work?
Burndown reduces the guaranteed amount on milestones the guaranty defines: a certificate of occupancy, a DSCR at or above a threshold for a stated number of consecutive quarters on the lender’s definitions, leasing at or above a percentage, a loan-to-value at or below a threshold on a new appraisal, a principal paydown, or a date. Each milestone reduces the guaranty by a stated amount or to a stated level. Almost every guaranty requires the borrower to deliver evidence and request the reduction in writing; the reduction is not automatic.
Release ends the guaranty. It occurs on repayment, on completion for a completion guaranty, and on an assumption or transfer the lender approves with a substitute guarantor. Carve-out guaranties last for the life of the loan and are released only at payoff. The release should be a signed document in the loan file; an unreleased guaranty remains a contingent liability on every later net worth test.
Is it “guaranty” or “guarantee”?
Loan documents use “guaranty” as the noun for the instrument and “guarantor” for the party that signs it. “Guarantee” is the verb (the guarantor guarantees the loan) and appears as a noun in general usage. Both spellings describe the same obligation.
How guaranties show up in LoanBoss
Recourse is among the critical loan provisions the LoanBoss team abstracts from each loan. LoanBoss tracks recourse and burndown on balance sheet and construction loans, and produces a real-time, exportable SREO.
Frequently Asked Questions
Who signs a guaranty?
The guarantor: the sponsor’s principal, a parent entity or a fund with assets beyond the property. The borrower entity does not sign its own guaranty.
What is the difference between a payment guaranty and a carve-out guaranty?
A payment guaranty makes the guarantor liable for the debt, in full or in part, whenever the borrower fails to pay. A carve-out guaranty makes the guarantor liable only for losses from specified bad acts, and for the whole loan only on a full recourse trigger.
Does a guaranty end when the property is sold?
Only if the lender releases it in writing. On an assumption, the lender approves a substitute guarantor and releases the seller’s guarantor; on a payoff, the guaranty is released with the loan. Without the release, the guarantor remains liable.
What happens if the guarantor breaches a net worth or liquidity covenant?
The breach is a default under the loan, with the remedies the documents provide, even if the property is performing. Lenders commonly allow a cure period to restore the covenant or provide additional collateral.
Can a loan have more than one guarantor?
Yes. Where several principals guarantee a loan, the guaranty commonly makes them jointly and severally liable, so the lender can collect the full guaranteed amount from any one of them.
Related Terms
- Recourse and Non-Recourse Loans
- Covenant
- Construction Loan
- Loan Abstract
- Recourse and Guaranty Burndown: Tracking Guarantor Exposure Across a CRE Portfolio
- Debt Management for Family Offices Holding Commercial Real Estate Loans
Part of the LoanBoss CRE Debt Glossary. For hedging-specific terms, see Pensford’s resources.
Sources
- LoanBoss CRE Debt Glossary