Chapter 11 or Subchapter V Can Ease the Burden of Personal Guarantees

For many small-business owners, a personal guarantee is part of doing business. A lender, landlord or supplier asks for a signature and the owner signs, often without weighing what it means. But a guarantee turns a company obligation into a personal one. If the business seriously falters, the creditor can pursue the owner’s home, savings and other assets directly.

Personal guarantees turn up in many places. Commercial landlords routinely demand them, sometimes for the full lease term. Bank lines of credit and equipment financing agreements usually include them and key vendor credit applications can put guarantee language in the fine print. Small Business Administration loans generally require personal guarantees from anyone owning 20 percent or more of the business. In financial straits, these obligations put pressure on both business and personal assets.

A Chapter 11 or its streamlined small-business version, Subchapter V, does not by itself erase the owner’s personal liability. A guarantee is a separate contract and the automatic stay that takes effect upon filing a petition generally protects only the company. Even so, a reorganization can help reduce the owner’s exposure in practical ways, such as the following:

• Paying guaranteed debt through the plan — A confirmed Chapter 11 or Subchapter V plan that pays guaranteed claims in full or substantially over time shrinks what is left to collect from the guarantor. Plans are often structured with this goal in mind.
• Creating leverage to negotiate — A court-supervised process gives lenders a clear picture of what they will recover. Many prefer a negotiated deal, such as reduced payments, extended terms or a guarantee release in exchange for plan support or a modest owner contribution.
• Seeking temporary protection for the owner — In some cases, the company can ask the court to extend the automatic stay to the guarantor. Courts may grant this when collection actions against the owner could derail the reorganization.

Subchapter V adds its own advantages. There is no creditors’ committee and the absolute priority rule does not apply. That means owners can generally keep their equity if the plan commits projected disposable income for three to five years. A Subchapter V trustee also helps broker consensual deals.

However, there may be situations where the guarantor needs to consider a separate personal bankruptcy. It may be warranted when creditors have already won judgments, started garnishments or moved against personal property. Owners carrying significant personal debt beyond the guarantees will likely have a greater need to pursue their own Chapter 7 or Chapter 13 case. 

Timing matters. Owners who get advice before defaults cascade keep more options open for the business and for themselves. An experienced bankruptcy attorney can review every guarantee you have signed and map out a strategy that protects both you and the business. 

The Law Offices of Michael Jay Berger in Beverly Hills represents businesses throughout California in Chapter 11 and Subchapter V bankruptcy cases. Call 310-271-6223 or contact us online to schedule a free initial consultation.