A personal guarantee is a promise that if the business can’t pay the debt, you will personally take over the obligation. It is a huge risk, and yet business owners sign them every day. The personal guarantee gives a business creditor, such as a bank, recourse against a business owner’s personal property. So when the business fails, the guarantee doesn’t fail with it. Here’s what that domino effect looks like. First the business fails and can’t pay its obligations. The creditor goes after the business owner under the personal guarantee. Then the business owner can’t make good on that guarantee and files personal bankruptcy. The guarantee is the prime reason for filing bankruptcy and its elimination is the prime goal.
What if the reverse situation occurs - the business owner has personal money troubles that are not even related to the business, and files bankruptcy? In that case, the owner might not owe anything on a guarantee yet, or might not even be aware that such a contingent liability exists in the first place. Sometimes the guarantees are hidden away in the fine print of a credit application with a supplier.
New Debts Under That Old Guarantee
So here’s the big issue: the business continued to operate and went on to make new obligations after the owner had been discharged. Is the owner now stuck for the new debts under that old guarantee, or did the discharge put a stop to any future responsibility?
In Reinhart Foodservice LLC v. Schlundt, a case from federal district court in the Eastern District of Wisconsin in 2022, the owner of a restaurant had guaranteed the restaurant’s debts to a food supplier. The owner filed bankruptcy, and got a discharge. He didn’t list the supplier as a creditor; so the supplier didn’t have any notice of the case. Unaware, the supplier continued to sell to the restaurant on credit. Four years later, the restaurant failed. The supplier went after the guarantee, but the owner said the guarantee had been discharged.
The district court reversed the bankruptcy court’s decision. The owner signed the guarantee before filing for bankruptcy, but their liability under the guarantee didn’t come into play until the company actually made the purchases, which happened after the bankruptcy. Because of that timing, the liability wasn’t discharged. The court didn’t reach the issue of notice. The owner appealed to the Seventh Circuit. In other words, the discharge never reached debts that did not exist yet when the case was filed.
The supplier claimed it wouldn’t have extended credit to the restaurant without a reaffirmed guarantee if it had known about the owner’s bankruptcy. And yeah, probably true. But their own argument actually hurts them: The rule the court adopted says that no reaffirmed guarantee is required, and the lack of notice doesn’t matter. Nonetheless, creditors should always insist on a reaffirmed guarantee instead of relying on the ruling.
Reinhart isn’t the only case like this. In In re Schaffer, decided by a bankruptcy court in the Western District of Virginia in 2018, notice was never in dispute. Without the “they didn’t get notice of the bankruptcy” complication, the question is more narrowly and sharply defined. Two individual owners of the business personally guaranteed their business’s debts to the supplier. Each owner filed for Chapter 7 bankruptcy, properly listed the supplier among their creditors, and received a discharge of debt. But the business continued its operations and continued to buy from the supplier on credit. The business eventually went out of business, and the supplier tried to enforce the guarantees for all purchases after the business owners’ bankruptcy filings.
The court held the guarantees were still enforceable. Liability hadn’t been discharged because the claim arose when the orders were placed after the bankruptcy filing, not before. The key seems to be that the owners never revoked or terminated the guarantees. That’s odd, because you would think filing for bankruptcy and listing the guarantee on the bankruptcy schedules would have been enough to revoke it. Instead, the court seemed to find the business’s ongoing orders, which the owners apparently knew about and benefited from, sent the opposite message.
There’s no guarantee that every court will think the same way. For example, in In re Lipa, a Michigan bankruptcy case decided by Judge Rhodes, the court held that all obligations from a guaranty that the debtor signed before filing, including the purchase of goods after the filing, could be discharged. All of it, in the court’s view, was a contingent claim. The court reasoned, in part, that the law wants to give the debtor a fresh start.
Before Filing
So what can an owner who signed guarantees do before filing? First, make sure you disclose every single debt you’ve guaranteed on your bankruptcy schedules. Second, if your main goal is to limit your personal liability, you should send the creditor a letter disclaiming future liability under the guarantee.
Now, there’s a downside to sending the notice, as it might also tie your hands upstream: the creditor may just decide not to extend credit to the business without a reaffirmed guarantee, which is what the supplier in Reinhart said it would have done. And if you don’t send the notice, you have to hope that you’ll be able to convince a future court that the discharge eliminated your future liability, or that the act of bankruptcy itself revoked the guarantee. Not a sure bet. Those arguments have won in some courts and lost in others.
The short version for owners: a personal guarantee doesn’t just evaporate when your company folds or when you file for bankruptcy. It can still follow you and come back for debts the business adds later, unless you make a point of taking care of it. So learn which debts you’ve personally promised to cover.
