Am I personally liable if my business can’t pay its commercial lease?

The typical commercial lease is one of the largest liabilities a business owner signs. And in today’s high rent world, with a building lease often running 5 years or longer, it’s easy to fall behind in a hurry. Then as soon as there’s a bad month or two, that rent comes due and it’s really tough to get back on track.

What most people overlook is the fact that these debts are most likely personally guaranteed. By that I mean that the obligation to pay that rent or that loan is likely to be contractually owed by the owners of the business as well as the business itself. In other words, an owner who signs a personal guarantee is legally responsible for those debt obligations if the company fails to make good on its contractual responsibilities. And a landlord can come after the owner personally, in an effort to recover their money. The owner’s home could be liened, bank accounts garnished and a judgment made against them.

Many people take great comfort in the fact that they incorporated themselves. Or have their business under the umbrella of an LLC. Often, they reason that the LLC’s protection will keep them from incurring personal losses for the operation of the business. Of course, LLCs and corporations can limit liability for tort or negligence claims where a customer or worker is harmed. What many owners don’t realize is that when a commercial lender or landlord is considering a business for a loan or lease, they have done their homework. Commercial lenders know that there is very little equity for an LLC in most small businesses. So they simply require a personal guarantee in order to make the deal with you or your company. Unfortunately for the owners, the limited protections of the LLC are often taken away with a simple signature. By creating these personal guarantees and other contracts, you’ve willingly agreed that you will make good on a contract - even if the business fails to do so. Once there’s a personal guarantee, then the landlord or bank or whoever can skip right past any corporate protections because the owner personally guaranteed the debt.

Business debt is frequently backed by personal or business collateral, including the very equipment the company must use to earn the income to pay the debt. The bank may wish to hold the title to your business equipment. That way, if the loan is not paid, they can get first in line to remove it and sell it at auction. One great example of how business owners can get caught by this is with SBA COVID loans, such as the EIDLs. For loans of $25,000 or more, the SBA took all of the business’s assets as collateral. Some lenders want both collateral and a personal guarantee. And before COVID, on many SBA loans, the bank or lending institution might ask to see your home title, place a lien on your home or your other collateral and even get the right to take it back if you don’t follow through and pay back the loan.

Personal guarantees come in all shapes and sizes. Normally, it’s right there in the paperwork you signed to get the loan or lease in the first place. Many times, your personal guarantee is in a separate document from the note. Sometimes it’s a paragraph on the contract you signed for the note.

Chapter 11 Bankruptcy for Businesses

Generally speaking, I can’t recommend filing bankruptcy as a knee jerk decision. Chapter 11 bankruptcy for businesses, and the subchapter 5 bankruptcy for small businesses have to be prepared properly if you are to achieve a true fresh start and keep the business. This can often be an involved and costly process. But if your company is really in trouble, and there’s no prospect of long term recovery, chances are that bankruptcy is a waste of your time and money. And having the business file bankruptcy really won’t protect you, the owner from being stuck with a bunch of business debt you can’t pay. That brings me back to looking at the problem from your point of view and discussing a personal bankruptcy filing. If the business is never going to be able to get back on its feet, and instead is just limping along, a filing of personal bankruptcy by you may be more practical. Sometimes, owners can just throw in the towel. They dissolve the LLC. But what they don’t realize is that if those owners never filed a case themselves, they are still on hook personally. That is the part of the problem that a personal bankruptcy filing fixes. Many people worry that they have to stop their business to file personal bankruptcy. That’s often not true.

Outside of bankruptcy, you may be able to attempt to negotiate a payoff or a settlement to resolve those debts. Some lenders may be open to accepting far less than the full amount owed. However, this is usually only something you might be able to do AFTER you’ve defaulted. Typically, the creditor writes the debt off and releases you in consideration for you coming up with the settlement money. Commercial landlords can be the most stubborn. They have the right to evict you for not paying. That makes negotiating a settlement with a landlord difficult until you have lost the space.

Chapter 7 or Chapter 13 Personal Bankruptcy

If the business has really collapsed or is about to fall, and you just want out, there can be hope.

Chapter 7 or chapter 13 personal bankruptcy is often a way to alleviate the debts you guaranteed by dumping the liability for debts into your bankruptcy case. Or maybe reconfiguring them through a repayment plan. If you want to get rid of the debt, but try to keep working, you can convert LLCs back to sole proprietorship prior to filing. The exemption for tools of the trade can protect up to $60,000 of value.

If a bankruptcy filing is not the best for you or your business situation, there are other options. For instance, you might not want to involve the courts at all. Just keep in mind that negotiation only works when you have money on hand to bring to the negotiation.