It’s tempting to think, “If I close the LLC, the debts die with it.” But if you sign a personal guarantee for your business’ obligations to a supplier or lender, that guarantee does not expire by simply ceasing your operations. A personal guarantee is just what it sounds like, a guarantee signed by an individual to support a debt obligation, that the individual will be responsible for the debt if the business (the debtor) fails to pay. The tricky thing to understand about a personal guarantee is that you have promised to pay the debts if the business doesn’t. Therefore, if you go ahead and dissolve your LLC, you can expect that the suppliers and lenders with whom you agreed to guarantee the debts will turn to you for payment. If the business still owes money, the creditor can still demand you pay.
A Personal Bankruptcy
Some owners hope a personal bankruptcy will finish the job. The issue is: can the guarantor be held liable on the new debt that the creditor extends to the business after the guarantor received a bankruptcy discharge? There are many different answers to this question, with most circuits having no binding precedent. But a federal case from Wisconsin, involving a restaurant that eventually closed its doors, shows how much a guarantee can survive.
David Schlundt was the sole member of the LLC that operated the restaurant called The Refuge. Schlundt had a supply agreement with Reinhart Foodservice, LLC. (In addition to the supply agreement, Schlundt signed an “Individual Personal Guaranty” where he agreed to personally guarantee prompt payment of any amounts owed by The Refuge to Reinhart. Schlundt had signed this in 2003, several years before the problem arose.) In 2014, Schlundt and his wife filed a joint Chapter 7 personal bankruptcy. They failed to include Reinhart as a creditor in the bankruptcy. Reinhart received no official notice of the bankruptcy. On April 11, 2014, the trustee in the bankruptcy filed a report of no distribution. (The case was a no-asset case.) Ten days later, Schlundt received a discharge.
The Refuge continued to operate for the next four years, and continued to obtain supplies from Reinhart on credit. In the summer of 2018, the restaurant closed with an outstanding balance owed to Reinhart of approximately $37,000. Reinhart sought to collect on David Schlundt’s guaranty. Schlundt refused, based on his 2014 discharge. Reinhart returned to the bankruptcy court, rather than continue to seek to collect the debt. The bankruptcy court cited to a Seventh Circuit case and concluded that the debt was discharged. Reinhart appealed. The U.S. District Court for the Eastern District of Wisconsin reversed, concluding that the bankruptcy court’s decision was based on “an overbroad reading of Saint Catherine” and “contrary to the plain terms of the Bankruptcy Code.”
The Court’s Reasoning
The court’s reasoning is worth following. Under 11 U.S.C. 727(b), a debtor’s Chapter 7 bankruptcy discharge extinguishes all “debts that arose before the date of the order for relief.” Translation: you get a clean slate for debts that existed before the bankruptcy petition date, but you don’t get a free pass on debts that come after. The court spelled out the key terms: (1) a “debt” is a liability on a claim; (2) a “claim” is a right to payment, whether or not such right is reduced to judgment, liquidated or unliquidated, fixed, contingent, matured or unmatured, disputed or undisputed, secured or unsecured; and (3) the “date of the order for relief” is the date the debtor filed for bankruptcy. That’s a lot of words, but here’s the point: the debtor gets discharged of debts before he files for bankruptcy, not debts after.
So did the debts in this case accrue before or after the order for relief? The Schlundts claim the debt accrued when David signed the guaranty back in 2003. In their view, that was true regardless of whether credit was extended before or after the filing. The court disagreed. “Promise” and “debt” are not synonymous. The district court of Maryland reached this same conclusion in 2017. In that case, the court determined that unpaid debts incurred under post-petition purchase orders, but owed pursuant to an unrevoked pre-petition guaranty, were not pre-petition debts discharged in the guarantor’s bankruptcy case.
The Guaranty Follows You
Now look at the case from the point of view of an owner thinking about shutting down an LLC. Closing the restaurant did not stop the owner’s liability. It was the exact moment that the supplier addressed the owner. You might think the owner’s answer was that the LLC is closed. But it wasn’t. His answer was, “I filed a personal Chapter 7 bankruptcy in 2014.” The court says he still owes the debts which arose after his Chapter 7 filing.
Since bankruptcy courts are divided over this issue, and since most circuits do not have a precedent decision on this issue, the issue will continue until the Supreme Court resolves it. Some courts’ rulings, Reinhart among them, raise the point that this might have been a different result if the debt had been listed and the guaranty revoked. The point for you here, I think, is you should notify everyone, and list the guaranty as cancelled or revoked in the schedules.
My advice for you is that if you are an owner planning to close the business, and if you signed a guaranty, you should get help before taking that step — and you should understand that the guaranty follows you.
