Consider the sentences below:
Kate went shopping with her friend that needed a new suit.
David mowed the law for his neighbor that was out of town.
So what's wrong with them? Grammatically, they are indeed correct. That can, in fact, refer to people, especially if the relative clause is restrictive. However, that doesn't mean that it's the best relative pronoun to use in this context. Compare the sentences above to the following:
Kate went shopping with her friend who needed a new suit.
David mowed the lawn for his neighbor who was out of town.
Even those who aren't strict about this rule will admit that they read much better. Many style books would favor these versions of the sentences as well. Keep the following guidelines in mind as you determine whether to use that or who.
When to Use Who
As a relative pronoun, who is fairly limited. Who (as well as its inflections whose and whom) can only be used to refer to people or entities equated with people (like deities and occasionally pets). It should not be used when referring to things or animals.
I followed the girl who was running down the street.
When to Use That
That can refer to animals, things, and people and should be used when the clause is restrictive. While that can be used to refer to human beings, it is not the preference. The following is a correct use of that:
Bill found the car that he wanted.
So if you have the option of that or who in certain contexts, what's the problem? You'd probably get different answers depending on who you ask. But for me, using that in reference to people is similar to referring to someone using the pronoun it. You wouldn't do that, would you? It would make that person seem less human.
Exception to the Rule
As you've come to expect with grammar rules, there is an exception . While you should use who in reference to people whenever possible, that can (and should) be used when the sentence has more than one relative clause and who has already been used. This will help avoid awkwardness and repetition.
That is the woman who shared her apartment with the man that took her money.
Keep these guidelines in mind when you need to use relative pronouns.