Do you own a restaurant, a store, a theater, a business that leases from a landlord, or any struggling business that has borrowed money? If so, chances are you have signed a personal guarantee somewhere along the way, for the bank, for the landlord, or for anyone else who had the leverage to ask. A personal guarantee is a promise to pay a business debt personally. If the business gets into trouble, the guarantor is on the hook. That was easy to live with while the business was healthy. It is a lot harder to live with now, and the question on your mind is probably what happens to those guarantees if you turn to Subchapter V, the newer, small-business version of chapter 11.
The short answer is that those guarantees may be wiped away – but it might have to be done by filing a personal Subchapter V chapter 11 case. And timing matters more than most owners realize. If you gave a guarantee, you may need to move faster than you would if you were simply the direct borrower on a business debt.
Subchapter V
Don’t forget that chapter 11 isn’t just for businesses — individuals can also file it. If your plan is confirmed, chapter 11 can wipe out most of your debts, including a personal guarantee, and you may be able to keep property that you would have to give up in a chapter 7 bankruptcy. Unfortunately, getting a chapter 11 plan confirmed is complicated, and it tends to cost a lot.
That is where the newer option comes in. Subchapter V was signed into law in August 2019 and took effect on February 19, 2020, just as the economic fallout from the COVID-19 pandemic started. It created a new kind of chapter 11. Subchapter V makes it easier and cheaper to confirm a plan of reorganization in chapter 11 bankruptcy, and a bunch of the rules you have to follow in a typical reorganization simply don’t apply. Even with a personal guarantee, you now have a significant possibility of a fresh start.
The Debt Cap
The rules on who gets to use the new small business bankruptcy (Subchapter V) are a little complex. For one thing, you can only qualify if your total noncontingent, liquidated debt at the time you file is below a certain amount. Before the pandemic, that cap was $2,725,625, but the CARES Act later raised it to $7.5 million. The original expiration date for the higher cap was March 27, 2021, but please check with a bankruptcy attorney to see if that has been extended.
Here is where your guarantees come in. Owners who have been in business for a while often have guarantees out to several creditors at once. If you’ve guaranteed a number of those debts, and if the guarantees all count toward the bankruptcy cap, you might owe more than the law allows you to. But until your company defaults on a loan or lease you guaranteed, you actually haven’t owed anything. The guarantee is dependent on the company’s debt. If the company never defaults, then you never go into debt. In that sense, a guarantee is contingent. It doesn’t count toward the debt limit when you file. And even after a default, the claim against you may still be unliquidated, which also keeps it out of the count. In other words, a small business owner who has given dozens of guarantees (to banks, landlords, and others with strong bargaining positions) will not hit the debt cap on the strength of guarantees that have not yet been triggered.
There is a second trap. Debts owed by any of your affiliates that are in bankruptcy count toward your limit as well. That means if your company goes into bankruptcy, and it’s a small case for the company, but it’s enough debt to put you over the limit, you would now be ineligible to file a personal Subchapter V. On the flip side, if you need to file for relief, you might be much better off putting in the paperwork to make it Subchapter V sooner rather than later.
That is why speed matters. Moving quickly does not mean the bankruptcy case itself will be quick (though it shouldn’t take too long). What it means is that the owner should decide to file a personal case early, before the company defaults and the owner’s guarantees are triggered.
There is another reason to move early, and it has to do with getting your plan confirmed. Under the Bankruptcy Code’s best-interests-of-creditors test, 1129(a)(7), each creditor in an impaired class has to either vote yes, or the court must make a finding that the creditor will get under the plan at least as much as it would get if the owner’s case were converted to chapter 7 and liquidated. Now think about your ownership stake in the company. If the company has begun to crumble by the time the owner’s plan is confirmed, a chapter 7 trustee might sell that stock for peanuts, so it is not difficult for the owner to prevail in that comparison.
The Right Lawyer
This type of bankruptcy is complex and requires significant experience. There is a right lawyer for your situation. Consumer bankruptcy lawyers, who almost exclusively handle chapter 7 and chapter 13 cases for medical debt, student loans, credit cards, etc., most likely have never been involved in a chapter 11 bankruptcy. They also might not know the full menu of out-of-court options available, such as a workout, an assignment for the benefit of creditors or a friendly foreclosure sale. If you are an owner who has personally guaranteed the debts of your business, do your research and get the right lawyer for the job.
It is hard to understate the importance of timing in a Subchapter V case. Act early, before the company defaults on its loans, before it files its own bankruptcy case, and while your guarantee claims are still contingent, and the odds are stacked in your favor. Wait, and you may miss the train entirely. And before you go down this path, of course, make sure that a bankruptcy case is the right answer. And get that advice sooner rather than later, from an attorney who knows his or her stuff.
