What Happens to Personal Guarantees When a Business Closes?

You took the lease at a time when you were pretty sure everything was going to work out fine. Or maybe you signed a personal guarantee for a supplier’s credit account. But the business fails, or you close down. Does the guarantee fail too? A recent decision from a U.S. District Court judge suggests that the answer might be no and even your personal bankruptcy might not wipe out what you owe.

Why does any of this matter for someone shutting a business? Well, when a business owes a supplier, the business is the debtor. But when you sign a personal guarantee, you become the guarantor. That means the person who the supplier turns to when the business fails to pay. When the business stops paying, for example, when it closes, then that’s often when the personal guarantee takes effect. Not when it ends.

In Re Schlundt

Consider the case that court decided. A restaurant entered into a credit agreement with a supplier in 2003. The only owner, David Schlundt, personally guaranteed the agreement. This was a continuing guaranty - it covered all present and future obligations that the restaurant owed to the supplier. The restaurant purchased goods on credit from the supplier for many years. Finally, in 2014 - eleven years after the guaranty was signed - Schlundt filed personal Chapter 7 bankruptcy and didn’t mention it to the supplier. During and after the bankruptcy he continued to purchase from the supplier on credit for the restaurant.

In 2018, four years after his discharge, the restaurant fell behind. The vendor demanded payment from the restaurant, the debtor, and from Schlundt, the guarantor. Schlundt informed the vendor that the business was closed, and that he had received a discharge from his earlier bankruptcy. The vendor went back to bankruptcy court and reopened Schlundt’s case, rather than risk sanctions for pursuing a debt that might have been discharged.

The parties both moved for summary judgment. The bankruptcy court granted summary judgment to Schlundt and concluded that under the guaranty everything was discharged in the bankruptcy. The supplier appealed to the federal district court for the Eastern District of Wisconsin, which reversed. In re Schlundt, 646 B.R. 478 (E.D. Wis. 2022). The court decided that liability under a guaranty signed before bankruptcy, for debt created by credit purchases made after bankruptcy, was not discharged.

I also noticed that the bankruptcy judge who heard the case agreed with the owner. It wasn’t until the case was appealed that the supplier won. That’s an indication this is an unresolved issue, and one that can depend on the specifics of a particular case: what state’s laws apply, and when each individual debt was incurred.

Why did the appeal come out the other way? Because in Wisconsin, a guaranty is a continuing offer to pay another’s debts. Each time you buy something on credit, the guaranty of payment for that purchase is considered a separate deal. Which means that every time after the bankruptcy, when the restaurant bought something, it was a new, separate promise by Schlundt to guarantee that payment, a promise that was not made until the new purchase was made. Because those new debts came into existence after the bankruptcy, the bankruptcy did not discharge them.

A Continuing Guaranty Does Not Get Magically Wiped Away

What does all this mean to you as the business owner? It means that even though Schlundt closed down his business, it didn’t necessarily close the book on this problem. As soon as the restaurant stopped paying, the supplier was able to pursue Schlundt as guarantor. And telling them the business was closed didn’t cut the matter off, because the guaranty extends to current and future debt. It’s continually expanding to take in whatever’s added to the account until the guaranty is ended, even if that’s many years after the signing.

Here’s where that bankruptcy comes in. Many owners think that if they go bankrupt their discharge wipes out every guaranty they’ve ever signed. This ruling suggests that a discharge only covers debts you had when you filed. If your business kept buying product on credit after you went bankrupt under an old continuing guaranty, those new debts may be yours, personally. Schlundt never told the supplier that he’d filed, and just kept charging.

There’s a lesson here, too, even if you have been in or are going to bankruptcy, and you continue operating your business. Old credit accounts backed by an old continuing guaranty do not reset. In the Schlundt case the supplier had no notice of the bankruptcy until after the business had shut down, so it never had the chance to ask for a new guaranty. Every new purchase quietly added to what he could personally owe.

All of this should be viewed as one judge’s interpretation of the law in a particular place and time. Creditors in the Eastern District of Wisconsin can rely on this ruling, and other creditors can use it in places where the court’s reasoning seems persuasive. But it’s not a ruling that applies in all places at all times. You should expect creditors to pursue this, however; it’s a powerful weapon.

The lawyers who represent creditors have drawn their own lessons from the case, and those lessons show you the creditors’ point of view. They advise creditors that if they hear a rumor that the guarantor has filed bankruptcy, they should check it out. If the guarantor did file, it’s a good idea to ask for a new guaranty on future purchases before extending more credit to the business. They also advise creditors to carefully and periodically evaluate the creditworthiness of the business and the guarantor, particularly if a credit agreement is several years old.

This means that signing a continuing guaranty does not get magically wiped away when you close the doors. As with this businessman, a continuing guaranty you signed years ago may still be in effect. Know what you signed and know what accounts remain open. If you filed personal bankruptcy but kept the business going and continued to buy on credit, don’t expect a discharge to cover everything. In this case, the supplier waited four years after the discharge and still was able to win on appeal.