There’s a ‘Gator Back There

We had fought the good fight, but it wasn’t to be. Nine months earlier my partner and I had realized – after two years of sacrifice – that the business wasn’t big enough to support both of us, so I left to establish Financial Managers, and Don took over the whole show. I retained my ownership interest, but I also retained my share of responsibility for the bank loan. In the intervening months, Don’s wife, who was also his business partner in an allied venture, had filed for divorce. That, and the recession, was killing both entities.

So we decided to close up shop. We had to pay the employees what they had earned, of course, as well as the payroll taxes, which he had let slide for several months. Our accounts receivable would cover that, we figured, and anything left over would go to reduce the bank line of credit. Our other creditors were upset, but we let them know that the bank had a prior claim and that the remaining assets wouldn’t reduce the bank debt very much. We rationalized that as a group they’d made more money from the business in its three years than we had.

The bank loan, however, was something else. We had co-signed personally for it, and since Don owned two-thirds of the stock, he had agreed to accept two-thirds of the $75,000 debt (worth about twice as much today). For two guys in the family formation stage of life who’d been living on $30,000 a year for a couple of years, that was significant. It was even more significant three months later when Don – to my great surprise and aggravation – declared personal bankruptcy, leaving me holding the total bag, since we had “jointly and severally” guarantee the original loan.

There was no question but that the banker saw it as my responsibility to pay off the loan. There was also no question on my part but that that was the right thing for me to do. My partner and I in the course of building our company had joked about the “what ifs,” and the prospect of putting my family out on the street after a home foreclosure was a significant incentive to commit endless hours to the business. Unfortunately, the incentive wasn’t symmetrical: he had no kids, I had five; he had an apartment, I had a house. When I had volunteered to leave the Company, I also had volunteered to leave the bank note behind. The bank didn’t share my sense of volunteerism once they had considered Don’s personal balance sheet. I couldn’t get off the note.

When Don defaulted, the Bank in effect said “We still have you, Brad. There’s no need for us to chase Don,” who had left New England by then. They didn’t want my house, or my car, or my first, second, third, fourth, or fifth-born. They let me name the terms – ten years of monthly payments at their prime rate (which got me out from under just as the heavy wave of the kids’ college bills started hitting in the mid- ’90s).

That was a significant bite out of my backside, no question, but it provided some valuable life experiences, ones which I have been passing on to my entrepreneurial clients ever since then. In the current environment, I am once again reminded of these lessons as I see some company owners and other stakeholders checking their loan documentation to see “just what it was that I signed.”

  1. Know your partner(s). If you and they are going to commit jointly and without limit to a loan, you need to see the detail of each other’s financial resources and have some candid conversations about your financial limits. Recognize that the lender will take the most readily available route to recover its funds, irrespective of your deal with your partner.
  1. Reassure your life partner. Without your spouse’s signed guaranty, collateralized by a mortgage, a lender can’t take your house (assuming it is owned as “tenants by the entirety,” which is available to married couples only). [See sidebar] Nevertheless, it’s a good idea to file a Declaration of Homestead before either of you signs a guarantee.
  1. Liquidity talks. The bank doesn’t want to foreclose on your house, much less your car, and they certainly don’t want to take the blame for institutionalizing your kids (even though you may have thought of it from time to time). Most lenders today advance funds on a personal guarantee only to the extent that you have liquid assets (stocks, bonds, cash) that you’re willing to pledge.
  1. Home equity walks. For commercial lenders, foreclosing on personal property is anathema. They’ll get a liquidator to squeeze cash out of your company’s receivables and equipment – that comes with the territory that is covered by your collateral agreement. But if you’re offering the equity in your home as loan collateral, they’ll suggest you visit their home equity department and come back to their desk with the cash.
  1. Keeping you tethered.In liquidation, the bank doesn’t want to oversee the collection of your receivables, much less to deal with your creditors. That’s your job. So you get your loan and leave the bank, leaving behind your personal guarantee… which floats just below the surface… acting like an inert log… until you look back and realize –There’s a ‘gator back there!!

Alligator Bites

Of even more interest than this May 4, 2009 dodge-the-bullet article at were the reader responses which followed.

The article…

“Lee County residents in increasing numbers are finding themselves on the horns of a financial dilemma. With their homes worth less than their mortgages, should they continue making their monthly payments or ditch the house and start over? It’s a problem faced by a lot of people: reported recently 32.2 percent of homeowners in Cape Coral- Fort Myers were upside down in their homes at the end of 2008.

“- Run out the clock. If you simply stop paying on your mortgage and ignore the threatening letters, eventually your lender will file for foreclosure against you. You won’t have to do non-emergency repairs on your house or make mortgage payments for the six months or longer it typically takes for a foreclosure lawsuit to plod through Lee County’s overloaded court system, where almost 30,000 foreclosure cases are ahead of you with about 2,000 new ones a month.

“- Hire an attorney. An attorney will negotiate with the bank for what’s called a “deed in lieu of foreclosure.” That means the bank agrees to let you transfer the deed to the bank in exchange for whatever you owe on the loan.

“- Get the bank’s attention. Lenders typically are more willing to discuss the terms of a mortgage with a borrower who’s stopped paying for a few months. You probably will not be able to negotiate a lower loan amount but might be able to get a lower interest rate or stretch out your payments – possibly making it in your interest to keep paying the mortgage even though you’re upside down.”

And the responses…

“Too much negative thinking and lousy advise. [sic] Like many my mortgage is higher than the worth,[sic] but by keeping my mortgage up and making improvements to my property it’ll reverse itself in two to five years, And probably be worth more than what I anticipate. You make a commitment-stick to it.

“What a STUPID article. It should be retitled: Top Four Ways to be an Irresponsible Schmuck and Lengthen the Recession. These exact reasons are why we are in this real estate fiasco in the first place. How about this advice: if you buy a home, live in it and pay your mortgage. The upside down price gap will start closing soon, just be patient and wait it out. Heck, I’m 80% upside down and you don’t see me sweating.

“Bad article…very bad. Look, I’m underwater on my place but I bought it knowing I could afford AT THE PRICE PAID. I will try to refinance when the situation changes; however, as a responsible home buyer, this article is offensive from start to finish.”

Draining the Swamp

From Attorney Marijo McCarthy regarding a spouse’s liability for the debts of their husbands/wives –

  1. With the signature of a single spouse and home owned as Tenant by the Entirety: lender can sue and attach a judgment, but not force a sale.
  1. With the signatures of both spouses and home owned as Tenant by the Entirety: if both spouses are involved in the business, lender can sue, attach and, if there is any equity left, may be able to sell, unless there’s protection of a prior Homestead filing and/or liens on record. If the lender persists, the couple can file personal bankruptcy and frequently protect the house.