Bankruptcy and Wind-Down Strategies for Personal Guarantors
The COVID-19 pandemic continues to impact businesses of all sizes in a wide variety of sectors. With rare exceptions, these businesses have borrowed money, signed leases and purchased inventory with the assistance of one or more personal guaranties, usually from the business owner. Personal guaranties are contracts executed in conjunction with a primary contract, typically a loan or lease. They may be unlimited or may limit the duration, monetary amount or both. Some guarantors pledge their own assets as collateral to further secure the debt of the borrower.
With the likelihood of a sharp increase in defaults on business debts as we end 2020 and begin a new year, it is prudent for both businesses and guarantors to understand the implications for a guaranty in both bankruptcy and non-bankruptcy wind-downs. This article discusses strategies in both contexts.
Guarantor Strategies when the Primary Obligor Files Bankruptcy
In the bankruptcy context, a number of issues arise with regard to guaranties. A bankruptcy filing immediately results in the extension of the automatic stay to prevent litigation, foreclosure, or other collection activities against the debtor. But what about the guarantor who has not filed bankruptcy? There are important options available to guarantors faced with a bankruptcy filing involving debt they have guaranteed.
Asset Sale Cooperation
If a debtor is going to sell assets as part of the bankruptcy case, a lender might agree to not proceed with collection efforts against the guarantor in exchange for the guarantor’s cooperation in disposing of the property through the bankruptcy process. This approach can help the lender gain input into the timing and manner of the liquidation of assets. Bankruptcy protection for a struggling business or business owner may be even more important during the pandemic because creditors are facing their own financial hardships and may be looking to strictly enforce loan agreements or even anxiously awaiting even a small default that allows them to enforce the guaranty.
Third-Party Injunction
A second important tool is that a debtor may be able to obtain an injunction from the Bankruptcy Court preventing a lender from suing the guarantor(s) for a specified period, including the entire time the bankruptcy case remains pending. If collection litigation has already commenced, the injunction might also extend to stopping (at least temporarily) the lender’s collection efforts against the guarantor.
The ability of a debtor to extend aspects of the automatic stay to a guarantor is especially critical when the guarantor is also the debtor’s principal and necessarily involved in the operations of the business and the responsibilities of bankruptcy. Obtaining the protections of an injunction will allow the guarantor to focus time, attention and resources on the underlying business rather than defending against guaranty collection litigation.
Guarantor Strategies in a Non-Bankruptcy Business Wind-Down
If a business is engaged in a wind-down of operations outside of the bankruptcy context, both the business and guarantors should consult with counsel to develop a comprehensive strategy to limit liability as extensively as possible. With COVID causing so many businesses to close, creditors may turn more quickly to a personal guaranty to protect their interests. Experienced counsel can facilitate an appropriate assessment of assets and liabilities of both the business and guarantor. Counsel can also undertake negotiations with lenders, landlords and other vendors. Taking a proactive approach with lenders and involving counsel early in the process will help a guarantor have the most options possible for negotiating and potentially limiting personal liability for the debts of the underlying business.
So, what can a guarantor do to protect themselves? First, an owner should try to avoid at the outset giving the lender a guaranty, perhaps by offering the lender alternative forms of protection. For example, if possible, offer a blanket business lien for your business’s assets sufficient to cover the amount borrowed without reaching any personal assets. If that is not an option, perhaps you have specific collateral to offer in lieu of a guaranty. This, in effect, is a limited guarantee saying if the business defaults, a specific piece of collateral is the lender’s “guarantee” of repayment. It has the effect of protecting the lender, and also protecting the individual by limiting the “guarantee.”
As a personal guarantor, it is very important to know what you have pledged. Is your guarantee unlimited so that a lender can collect the full amount of the indebtedness from you as an individual? Is it cross-collateralized and/or cross-defaulted so that a default under one contract may trigger liability under all obligations owed to that creditor? Is it a primary guaranty that allows a lender to collect from the individual even before trying to collect from the primary business contract?
Conclusion
Personal guaranties involving businesses can be complex, confusing, and surprising in scope. Consultation with experienced counsel can help protect your rights before a crisis arises.
Courtney Gilmer is a business attorney who guides debtors, creditors, committees and asset purchasers through workouts and Chapter 11 bankruptcy cases. She also represents public and private companies in financial services litigation and financial regulatory compliance matters. She is a 2002 graduate of Vanderbilt Law School.