A personal guarantee is a contract between you and the lender; bankruptcy is a court process that allows a debtor to discharge debt through the court system. By signing a personal guarantee, you are agreeing that you will cover the debt regardless of the company’s profits or failures. If your business doesn’t pay the loan, the bank can then use the personal guarantee to sue you and try to recover the money owed.
Many times, when you start a business and get a loan, the lender will require you to sign a document called a personal guarantee. This is very common, especially when a company is new, since most new companies have little collateral, and it gets lenders around the LLC or corporation an owner sets up to protect personal assets. If the business goes bankrupt or fails and its assets are distributed to other creditors, the bank could be left without a way to collect the debt. The personal guarantee was designed to give the lender confidence that you will always honor a company’s promise to pay, even if the company fails. When the business loan isn’t repaid, the bank can fall back on the personal guarantee and hold you responsible. In the case of default, the lender has the right to go after your personal assets and attempt to recoup the debt.
There Are Catches
So can bankruptcy get rid of it? Usually, yes. In most cases, personal guarantees on business loans will be dischargeable, and you will not have to pay the debt after bankruptcy. But there are catches. First, have an attorney check whether the guarantee is still valid. If the bank changed the terms of the loan without notifying you, they may not be able to enforce your personal guarantee. And a guarantee a bank demanded from a spouse who isn’t involved in the business might not be enforceable if it’s unfair.
Bankruptcy law allows you to discharge some debts, but not others. Under the Bankruptcy Code, some debts are simply nondischargeable and can’t be wiped out in bankruptcy no matter what. Suppose a restaurant owner gave the bank a false financial statement to get her loan, and the court later declared that debt nondischargeable. Even if her guarantee was discharged, she still owed the loan. In the case of a personal guarantee, bankruptcy can’t rewrite reality.
The second catch is who files. Personal guarantees are not affected by a business bankruptcy. If you signed a personal guarantee, your personal liability for the loan is not discharged. Worse, the bankruptcy trustee may treat the personal guarantee as an asset of the business bankruptcy estate and look to you for money to pay the company’s creditors. What the trustee is going to tell you is that the company simply messed up and failed to pay its debts and now you have to pick up the tab.
The same goes for a guarantee on a friend’s or relative’s loan. A guarantor is legally committed to responsibility for the loan if the primary borrower defaults. Their bankruptcy leaves you on the hook unless they pay the debt off in Chapter 13. Even if the borrower never pays the loan, you are still legally responsible for the loan. You’ll have to pay it or file your own case.
The third catch is collateral. Some guarantees include a security interest in your property, giving the lender a lien. A lien is a tool that allows a lender to secure repayment of a loan. A discharge means that your personal responsibility to pay the debt is extinguished. It does not take off any lien attached to the debt. The secured creditor still gets the asset if the bankruptcy debtor doesn’t make payments on the asset. Chapter 13 offers some ways to deal with that.
Type of Bankruptcy
Chapter 7 is the faster route. This type of bankruptcy is ideal for those who do not have significant income or property, but have lots of debt. It eliminates qualifying debts (such as credit card debt and personal guarantees) within about four months.
It can work for higher earners too. The means test applies only if the debtor’s debts are primarily consumer debts. If most of your debt is business debt, the means test doesn’t apply. This means that it is easier for some people with higher incomes to get into Chapter 7. A failed owner now earning a good salary elsewhere may still qualify, if losing property isn’t a concern.
Chapter 13 is typically only used by individuals, so you must file it in your personal name. You keep all of your property and usually pay a smaller portion of your personal debt through a plan, after which qualifying debt is discharged. Chapter 13 requires a repayment plan that lasts 36 to 60 months. A business owner can file for bankruptcy regardless of whether or not his or her business is still operating or has shut down. If your business is losing money, Chapter 13 gives you an opportunity to prop it up for a while to see if you can turn things around and keep it going. If it has closed, the catch is that you must pay creditors the value of your nonexempt property. Thus, Chapter 13 is an option for some business owners who wish to keep their property.
In a Chapter 13 plan, it is usually possible to get caught up on the mortgage or car loan. You can keep your house so long as you continue to make payments on your mortgage and you bring the delinquency up to date over the 3-5 year period of the plan. A cramdown can also reduce what you owe on some property to its actual value, payable through the plan. This is one of the major benefits of Chapter 13.
Personal Guarantee Insurance
What if you’d rather not file at all? The problem with a business guaranty is that it is hard to get it released until the debt has been paid. To mitigate this risk, you could purchase personal guarantee insurance. If you have to pay the guarantee from personal assets, it reimburses up to 80%, which might keep you out of bankruptcy.
While bankruptcy is designed to give debtors a fresh start, it doesn’t come without consequences. Talk to a bankruptcy attorney before choosing a path.
