It’s pretty common for small business owners to personally guarantee some of their companies’ obligations. And that can set off a chain reaction. If the company can’t pay its debts, the creditor goes after the business owner’s personal guarantee, possibly pushing the owner into bankruptcy court if the owner can’t cover the guarantee. In those cases, the guarantee is usually the main reason the owner ends up in bankruptcy, and wiping out the guarantee liability is usually the main thing the owner is trying to do.
It can happen the other way around, too. A company owner has given a personal guarantee on the firm’s debts and has run into financial trouble that has nothing to do with the business. In that case, the owner might file for bankruptcy, not owing anything on the guarantee yet and not realizing it’s a potential liability. Sometimes the guarantee tucks itself in a supplier’s credit form.
That raises a harder question. Suppose you were relieved from personal liability through a bankruptcy discharge, but the company racked up new debts afterward. If the business failed later and the creditor came after you, do you remain liable for them, or did the bankruptcy discharge cut off further liability under the guarantee?
Reinhart Foodservice LLC V. Schlundt
A federal district court in Wisconsin answered that question in Reinhart Foodservice LLC v. Schlundt, decided in 2022. Reversing the Bankruptcy Court, the court said a business owner’s own bankruptcy did not wipe out the owner’s later debts on a guarantee for his company’s debts. The owner, who owned a restaurant, had guaranteed that the restaurant would pay a supplier on time. The owner filed for bankruptcy and got a discharge. He failed to list the supplier as a creditor in his bankruptcy, and the supplier never found out about it otherwise. Not knowing that their customer had declared bankruptcy, the supplier kept selling goods to the restaurant on credit. The restaurant then went under four years later. The supplier then tried to collect on the guarantee the owner had signed, and the owner said he didn’t owe anything on it.
The District Court ruled that even though the guaranty was signed before the bankruptcy, it wasn’t until the stuff was actually bought that the debt popped up–and that was after the debtor’s bankruptcy, so it wasn’t wiped clean. The judge didn’t get into the notice stuff. The debtor is taking the decision to the 7th Circuit Court of Appeals.
Surprisingly, the supplier said that if it had known the guarantor had gone bankrupt it wouldn’t have sold the restaurant anything without the guarantor reaffirming his debt. This is probably true as a practical matter, but really it hurts the supplier’s case. A guarantee doesn’t have to be reaffirmed under the rule the District Court applied, and it makes no difference that the supplier never got notice of the bankruptcy. (On the other hand, suppliers should still demand a reaffirmed guarantee and not just take their chances on this ruling.)
Not the Only Decision
Reinhart is not the only decision along these lines, and in an earlier one notice was never at issue. There was a case in Virginia where two separate people who owned a company individually signed a guarantee of its debts to a supplier. Both of the owners filed for Chapter 7 bankruptcy. They properly listed the supplier and received discharges. The business kept running and kept buying from the supplier on credit. Later, the business went under and the supplier sought to enforce the guarantees for the business’s debts after the bankruptcy. The Bankruptcy Court determined that the guarantees remained valid. The debts were not dischargeable because they didn’t exist until after the purchase of the goods post-bankruptcy. What led the Bankruptcy Court to make this determination was that the guarantors never told the supplier to stop the guarantee. You’d think filing for bankruptcy and listing the guarantee as a liability would be enough to revoke it. The court saw it differently: the business went on placing orders, the owners apparently knew about them and benefited from them, and that sent the opposite message. The case is In re Schaffer, decided in 2018.
Not every court thinks this way. In In re Lipa, decided in 2017, for instance, Judge Rhodes held that all of a guarantor’s liabilities under a prebankruptcy guarantee were contingent claims, and therefore dischargeable, even liability for purchases the business made after the guarantor’s bankruptcy filing. He reached that decision in part because it makes sense for bankruptcy law to grant debtors a new start.
Protect Yourself from Future Liability as a Guarantor
A few things to learn from these cases to protect yourself from future liability as a guarantor:
- First, list every guaranteed debt in the schedules.
- Second, if your main interest is minimizing your personal risk, it’s best to send a letter denying any further liability under the guaranty to the creditor. The trouble is that may backfire; the creditor might not give the business a loan unless it gets a renewed guaranty (as suggested in Reinhart). If a debtor decides not to send such a letter, it will have to try to argue later that the bankruptcy wiped out future liability under the guaranty or that the bankruptcy effectively voided the guaranty–arguments that don’t always work.
So what does all this mean for an owner heading into bankruptcy, Chapter 11 or otherwise, while the company keeps operating? The decisions above turned on the owner’s own discharge, and courts disagree on whether it reaches debts the business runs up afterward. If the debtor wants the guarantees to be wiped out and not reinvoked after discharge, the debtor should do whatever is necessary to cut off future liability under them. Failing that, the consequences may come back to bite in the future.
