Contingent liability

A debt a person or company would owe only if something happens, most often a guaranty of someone else's loan that the borrower then stops paying.

A contingent liability is not on the balance sheet as a debt today, but it can become one. For a real estate investor or business owner the common case is a personal guaranty on another loan: nothing is owed while that borrower pays, and the full amount of the guaranty can come due if it stops.

SBA’s personal financial statement, Form 413, asks for four kinds: amounts owed as endorser or co-maker, legal claims and judgments, provision for federal income tax, and other special debt.

Lenders are told to count them. The OCC’s handbook for examiners says a bank should obtain information on contingent liabilities for both borrower and guarantor, and that a global cash flow analysis should weigh any actual or contingent liabilities and their effect on repayment. Fannie Mae’s guide tells lenders on small multifamily loans to consider contingent liabilities when judging net worth.

Example: an owner with $3,000,000 of net worth who has signed guaranties on $6,000,000 of loans on four other properties looks different from one with the same net worth and no guaranties. Disclose each guaranty, say whether it is full or limited, and show that the property behind it covers its own payments.

Go further

• Deal summary builder: A one-page summary where guaranties on other loans can be disclosed.
• When a bank says no: Next steps when a lender declines over the guarantor's other debts.
• Deal summary builder: Turn the facts of a deal into a clean one-page summary you can copy or print. Nothing is saved or sent.
• Global cash flow, explained step by step: A property can cover its loan while the people behind it cannot cover their other debts. Global cash flow is the test that looks at all of it at once.
• Guarantor strength and recourse, explained: A guaranty is the lender's second way out. Whether you sign one, how much it covers and what the lender checks before accepting it shape a commercial loan as much as the rate does.

Related terms

• Guarantor: A person or company that promises to repay a loan if the borrower does not. On a loan to an LLC or corporation, the guarantor is usually an owner.
• Personal guaranty: A signed promise by an individual, usually an owner, to repay a business or real estate loan personally if the borrowing company does not.
• Global cash flow: The combined cash flow of a borrower, its owners and their other businesses, set against all of the debt payments those same parties owe.
• Debt schedule: A table of every loan a business or borrower owes, showing for each the lender, balance, payment, maturity date and collateral.
• SBA Form 413 (Personal Financial Statement): SBA's personal financial statement. Each 20 percent owner and each guarantor except a supplemental guarantor gives one, or the lender's own equivalent, signed and dated within 90 days.
• Post-closing liquidity: The cash and other liquid assets a borrower or guarantor still holds after paying the down payment and closing costs on a loan.
• Carve-out guaranty: A guaranty on a non-recourse loan that makes the guarantor personally liable only if the borrower commits listed acts, such as fraud or a voluntary bankruptcy.
• Standby letter of credit: A bank's written promise to pay a third party if the bank's customer does not repay a debt or does not perform an obligation.

Plain definitions for orientation, not legal, tax or credit advice. A lender's own policy decides what it will do.