When a business owner signs a personal guarantee, they become personally responsible for a company debt. In other words, if the business can’t pay the debt, the business owner can be forced to pay it. Guarantees come up when a company is buying some product or supplies on a credit account, or leasing or buying real estate. The vendor or lender might ask the person signing to guarantee the transaction; if the company fails to pay, the person will have to step up. Creditors often use them with small businesses because of cash flow problems. For business owners, a personal guarantee can be a real issue.
Sometimes, the person who signed a personal guarantee files for bankruptcy. Does bankruptcy free them from the personal guarantee? At Delancey Street we negotiate with merchant cash advance funders and lenders for business owners, and this is one of the questions we hear most. The answer depends on who files. If you file for bankruptcy in your own name, then the personal guarantee will likely go away. But if the business files, no matter what happens to you personally, the personal guarantee remains. Here are six things worth knowing.
If Your Company Enters Bankruptcy
First, the company’s case doesn’t touch your guarantee. If the company files, but the business owner does not, then the personal guarantee is likely to remain. But remember that when you have a personal guarantee, you owe the money. Not the business; you personally. If your company enters bankruptcy it will not release you from the personal guarantees you signed. So when the business stops paying, the lender will come after you for the guarantee. Often the signer has two choices: pay from personal funds or file personal bankruptcy if there is no money.
Second, a Chapter 7 case filed in the company’s name does even less than owners expect. Many people don’t realize that the company gets no discharge in Chapter 7. If you’re not the one in Chapter 7, then you’re not the one getting a discharge. It might be different if the company debt were negotiated in Chapter 11, but relatively few Chapter 11 cases are filed each year, so that route won’t fit most of the owners we talk to.
The Personal Guarantee Can Be Discharged
Third, if you file in your own name, the picture changes. Not every debt can be wiped out in bankruptcy, but personal guarantees can. If you signed a personal guarantee, and you file for bankruptcy personally, then the personal guarantee is likely to go away. In other words, if the company doesn’t pay, you’re on the hook. But if you file for bankruptcy, the personal guarantee can be discharged. Plus, getting yourself out of personal debt such as credit card debt or medical bills is a pretty good side benefit.
Fourth, your own case may count as a business bankruptcy. An individual can file either a personal or a business bankruptcy. It depends on the percentage of business debt compared to consumer debt. For example, if a business debtor was individually liable on a $100,000 business lease and $50,000 of personal credit card debt, it would be a business bankruptcy because the debt attributable to business activities exceeds the amount attributable to personal activities. Of course, it is still a personal bankruptcy. So you can use it to discharge the debt attached to the personal guarantee. A bankruptcy case brought in the name of a company will always be a business bankruptcy since the company’s debts would be business debts, with no consumer debt for things like living expenses and food.
Why does this matter? Because if there is more business than consumer debt, then you don’t have to pass the means test for a Chapter 7 bankruptcy. That test decides whether someone is entitled to a Chapter 7 discharge. But if your consumer debt is larger, the means test applies and it could limit your right to a discharge. Skipping the test is a real help to owners who have moved on and earned a large salary elsewhere.
Fifth, Chapter 7 is not always the best option for owners with lots of property they want to keep. The best option may be Chapter 13 for people with assets they don’t want to part with.
Sixth, sole proprietors are a special case. If you’re a sole proprietor, it’s all you. The business is you, and the business debt is your debt. Sole proprietors are personally responsible for business debts and personal debts. If you file bankruptcy in your own name, all your debts, and any nonexempt assets, are included. As a result, Chapter 7 will wipe out the business debt and liability for the personal guarantee.
Bankruptcy Lawyer
Before you choose, consider speaking with a bankruptcy lawyer. Please note: we are not a law firm, and when bankruptcy is the right choice we’ll refer you to an independently vetted attorney. Our advisors negotiate with funders and lenders for less than the total balance owed. The initial consultation is free and confidential, and if bankruptcy is the appropriate path we’ll let you know on the first call.
