You as the Guarantor Remain Liable
Even if a business shuts down, you as the guarantor remain liable for any outstanding business credit card balances, loans, lines of credit, leases, etc., you personally guaranteed. The business is closed, but you did sign, so you owe. According to the U.S. Small Business Administration, 50 percent of small businesses fail within five years. The reasons are often lack of capital, bad credit, or high debt.
Most of the time, when you own a small business the loan is written in the name of the corporation or LLC. However, at the time the loan was approved, you signed a document called a personal guarantee. In plain English, that means “I, [owner], guarantee that the business will pay the debt to the bank, if it doesn’t, the bank can come after me.” Lenders insist on one because small businesses are perceived as risky. The personal guarantee gives the creditor an additional layer of security. If the small business defaults on a loan, the guarantor takes personal responsibility for the remaining balance. You are, in fact, on the hook.
That debt usually comes in a few familiar forms. Business credit cards are unsecured revolving loans. This allows the business to record business expenses separately from personal expenses on their books, so it’s much easier to file business and personal taxes. Lines of credit are like business credit cards, but subject to a credit review and annual approval. Conventional small business loans have floating or fixed interest rates and are paid on a monthly or quarterly basis. Commercial leases on business premises, equipment and vehicles often have personal guarantees from the owner.
Then there are merchant cash advances. Merchant cash advance providers check the business’ debit and credit card sales and advance cash against those transactions. They also file a UCC lien against the business assets (which includes the bank account) and usually collect payment daily or weekly directly from the business’ bank account. Annual effective rates can be as high as three digits. Default rates range from 20% to 30%. The borrower is often required to sign a “confession of judgment” - which means that the lender can get a judgment against the debtor without having to file a lawsuit. Rates that high mean the debtor can get caught in a vicious cycle. The advance typically will eat up a lot of the business’s receivables and income.
SBA loans, including EIDL, 7(a), 504 and Microloans, carry guarantees too. If the debt is more than $200,000, you will have signed a guarantee. If it is less than $200,000, you may or may not have signed a guarantee. In either case you may have signed a UCC filing against all of the business’ assets in case the business fails to pay. If the loan is for a sole proprietorship, you are liable because there is no separate corporation or LLC.
An Individual Filing and Seeking Bankruptcy Relief
I understand that a lot of small businesses see the word bankruptcy as the dirty word and wrinkle their nose when they hear it. Some say they will never file for it. Yet, in reality, bankruptcy is considered by many owners as the natural progression if they have tried other methods and still have out of control debt. It is important to remember that the question for us is not about the company filing, but rather about an individual filing and seeking bankruptcy relief.
A business is not entitled to a discharge in a corporate bankruptcy. However, the owner can file an individual bankruptcy and discharge the business debt, including business credit cards, business loans and lines of credit, SBA debt, lease and contract obligations signed by the owner, and lawsuit judgments. The automatic stay also stops all collection activities including lawsuits, collection calls, frozen bank accounts, garnishments and foreclosure auctions.
If the company has almost nothing and is shutting down, the owner can file Chapter 7 or 13. Chapter 7 will let the owner discharge his liabilities in a timely fashion and get a fresh start. Chapter 13 will force the debtor to make some payments through a 60 month plan, but in some cases, the debtor only has to pay a few percent of the outstanding claims. The chapter 7 means test, which often prevents debtors with high incomes from qualifying for chapter 7, does not apply where the majority of debt is business debt; business debts incurred on personal credit cards do not count as business debt for this purpose. Chapter 13 may be a better option in situations where the debtor has non-exempt property that could be liquidated in a Chapter 7 case, but the debtor wishes to, and can pay the creditors the non-exempt value through the plan; or in situations where the debtor needs to catch up on a type of obligation that Chapter 7 cannot address, such as a home mortgage or recent income taxes. And you must choose Chapter 13 if you have too much excess monthly income (according to the budget form), even though you are exempt from the bankruptcy means test.
Bankruptcy for Businesses
If the business is still viable, there is another route. Subchapter V of Chapter 11 is a form of bankruptcy designed to make the process easier and less expensive. To qualify, the business can’t be just owning or operating a single property. It has to be active. And combined, its secured and unsecured debt can’t exceed $7,500,000. If so, it can reorganize its debt and stay in business.
Filing a corporate Chapter 7 for the company itself rarely makes sense. Bankruptcy for businesses is typically very costly, never results in the business being given a discharge and therefore you don’t get a fresh start, there are often no corporate assets to sell to pay your creditors, and depending on how you maintained your business records, you may have improperly transferred funds or treated companies in a preferential manner. An individual bankruptcy that includes the personal guarantee for the business debt allows the debtor to get rid of the debt, and get a fresh start. It depends on the chapter, and your income, and if the business is still running. In the end, it’s your money, your obligations, and your call.
