Running your business is hard. Trying to survive an economic downturn? That’s really hard. Especially when you’re answering to a bunch of banks. All that gets worse when you’ve put your house and your life savings on the line to take a shot at your business. For most owners, that last part happened the day they signed a personal guarantee. Personal guaranties are a standard part of financing small businesses. However, this leaves small business owners in an unenviable position if the business fails. Once that happens, the owner is usually stuck with any personal guaranties.
A personal guarantee is exactly what it sounds like: a promise to repay a loan or other debt in case the business fails to do so. It means that if the business can’t pay its debts, the guarantors are personally responsible for the balance. The logic is that if the business can’t pay its debt, then the creditor will come after the person’s personal assets. So it is no surprise that one of the most common questions business owners ask during consultations is: will this bankruptcy cover my personal guarantee?
Here’s the short answer. Yes, a business bankruptcy lawyer can deal with the guarantee, and your bankruptcy attorney should be able to help with this problem just as well as they help with the bankruptcy case. The route, though, is usually not the company’s case. You could restructure a personal guarantee by filing your own case under Subchapter V. Your lawyer can probably help with it, and your lawyer should help you figure out if this is the best way to handle a personal guarantee. Subchapter V of Chapter 11 may seem incomprehensible at first glance. Hopefully, this summary will cut through some of the legalese and explain how it applies to an owner holding a guarantee.
Subchapter V was introduced by the Small Business Reorganization Act of 2019 (SBRA). It became effective early in 2020. The Coronavirus Aid, Relief, and Economic Security Act (CARES) increased the Subchapter V debt limit to $7.5 million. It has been increased before, so check with your lawyer what the limit is on the day you would file. Soon after the law took effect, some individuals began using Subchapter V to restructure personal guaranties of debts left behind by businesses that had already failed.
Small Business Debtors
Eligibility turns on Section 101(51D) of the Bankruptcy Code. In short, you have to be “engaged in commercial or business activity,” your debts cannot exceed $7.5 million, and at least 50% of those debts must have come from your business. Courts have interpreted this to mean that debtors whose debts are at least 50% business debts - such as personal guarantees - qualify as small business debtors. For a guarantor, that is the whole point: the guarantee counts as business debt, even though you signed it personally.
The open question was whether you still have to be running a business. In the case of In re Charles Christopher Wright (Bankr. D.S.C.), the debtor had 56% of his debts as business debt from his defunct businesses. His total debt was within the statutory limit. The court found that the SBRA does not require a debtor to be currently engaged in business, and he is engaged in business activity “by addressing residual business debt.” The reasoning was pretty logical: business debt that needed to be restructured was still business debt even if the business was gone. By extension, though, a guarantor could satisfy that requirement. They don’t need to be doing business, but if 50% of their debt is from personal guarantees, then they are addressing that residual business debt.
Similarly, in In re Andrew and Christine Blanchard (Bankr. E.D. La.) the bankruptcy court found that the guaranties for business loans constituted business debt for purposes of the SBRA. That court also found that the Code does not say a small business debtor must be currently engaged in business. The couple’s debts came from businesses they were still operating and from ones that had closed, the total was below the limit, and the debtors qualified for Subchapter V.
Residual Business Debt
So what does this mean for you? Once the Subchapter V plan has been completed, you (as an individual) will receive a discharge of the remaining debt. This is helpful for debtors who may not qualify for Chapter 7 because their monthly income is too high or who want to avoid liquidation of their assets in Chapter 7. (Maybe you read this and said, “I fit this description.”) To be sure, filing a Subchapter V case is not a get-out-of-jail-free card for a business owner with a business guarantee. Nor is it a free pass on a business’s debts. Instead, it is a way for a business owner to address the residual business debt and come out the other side.
It is also a lighter process than an ordinary Chapter 11 case, where confirming a plan is more demanding. In Subchapter V, the trustee actively works to facilitate, and if necessary mediate, a consensual plan. A disclosure statement is not required. And administrative expense payments can be delayed. Those differences should make it easier for an individual to get a plan confirmed, and with it, to restructure or discharge the guarantees.
Here’s a warning: take this case seriously. The process is quick - a status conference must be held within 60 days of filing, and the plan must be filed within 90 days. Your lender knows this. A creditor that gets notice of a Subchapter V case cannot sit back the way it might in a typical Chapter 11; its lawyers will review their files and immediately decide how best to assert its interests - negotiate with the debtor or take an active role in the case. You are helping yourself by getting on top of it early, with your records in order before you file. The point is to move quick.
So, does a business bankruptcy lawyer handle personal guarantees too? Increasingly, yes, through a Subchapter V case of your own. That could be a good solution if you don’t have a business to file for Chapter 11, and your guarantees make up more than half of your debt. It is still a good idea to talk with a business bankruptcy lawyer about the specifics of your situation. When you meet one, ask whether you would qualify as a small business debtor yourself and what share of your debt is business debt. Keep in mind that bankruptcy law is a specialized field, and in some instances, you may need additional representation. The takeaway: Individual debtors whose personal debts are tied to a business can qualify for this process, even when the business is gone.
Debt Settlement Firm
Bankruptcy is not the only option, though. Before you file anything, think about how important it is for you to get immediate relief (not having creditors harassing you day and night is very stressful and exhausting - we’ve heard that 1000 times) versus the effort of negotiating with creditors on your own. Or, if nothing else, just a proposal to a single creditor to settle the whole debt for less than full payment. That is the work a debt settlement firm does, and it is worth weighing next to Subchapter V before you choose a path.
