Whether you can get rid of a personal guarantee in a business bankruptcy will depend on whether you or a business files for bankruptcy. If you file for bankruptcy, you'll likely be able to erase or "discharge" a personal guarantee. The personal guarantee won't be discharged if the company whose debt you guaranteed files for bankruptcy. You'll remain responsible for paying for it.
What Is a Personal Guarantee?
When you agree to sign a personal guarantee, you become personally responsible for a company debt. You must pay it if the company isn’t able to do so. It’s a mechanism creditors use to ensure debt payment, especially when dealing with small businesses, because they tend to suffer from cash flow problems.
How a Personal Guarantee Works
When a company uses a credit account to buy product or supplies—or enters into a contract, such as a lease or a real estate purchase—the vendor or lender might condition the transaction on an agreement that the transacting individual will personally pay the debt if the company cannot satisfy it. The contract memorializing the deal is called a “personal guarantee.”
When a business fails to pay, the lender will pursue the personal guarantee, often leaving the guarantee signer with one of two options: pay the company debt out of individual assets or, if the signer doesn’t have the funds, file personal bankruptcy.
Will a Business Bankruptcy Eliminate a Personal Guarantee?
It depends. Although not all debts can be discharged in bankruptcy, personal guarantees are dischargeable. Learn about nondischargeable debts you can’t eliminate in bankruptcy.
However, the question is misleading because whether or not a bankruptcy is a business bankruptcy doesn’t determine the discharge of a personal guarantee. The critical factor is whether the person who owes the debt files a business or personal bankruptcy in their own name.
Why You Must File the Bankruptcy Case, Not the Business
A bankruptcy filed by a person or entity other than yourself will not discharge your debt. Because a personal guarantee is your obligation, not that of the organization, a Chapter 7 business bankruptcy in the company's name won’t eliminate your personal guarantee. Many people don't realize that even the company itself doesn't receive a debt discharge in Chapter 7.
The outcome might be different if the company debt were negotiated in a Chapter 11 case. However, relatively few Chapter 11 cases are filed yearly and this option won't apply to most readers.
What Are the Differences Between Business and Personal Bankruptcies?
Bankruptcies filed by individuals in their name can be business or personal. What determines whether it’s a business or personal bankruptcy is the percentage of business and consumer debt.
For instance, suppose you owe $100,000 for a personally guaranteed business lease and $50,000 of personal credit card debt. In that case, your bankruptcy filing would be a business bankruptcy because your business debt exceeds your consumer debt.
By contrast, a bankruptcy filed in a business’s name will always be a business bankruptcy because all debt will consist of business debt incurred due to pursuing business activities. None of the debt would be consumer debt incurred for things like living expenses and food.
So why does it matter whether a bankruptcy case is called a business bankruptcy? An individual with more business debt than consumer debt is exempt from taking the Chapter 7 means test, which determines whether someone is entitled to a Chapter 7 debt discharge.
You can get more answers to your business bankruptcy questions by reviewing Frequently Asked Business Bankruptcy Questions.
How to Wipe Out a Personal Guarantee in Bankruptcy
You can erase a personal guarantee if you file for bankruptcy in your own name.
An Individual Can Discharge a Personal Guarantee
Since a personal guarantee is an individual obligation, people can only eliminate it by filing for bankruptcy rather than putting the company in bankruptcy. Doing so can be quite beneficial in several ways. For instance, you can also:
- wipe out other qualifying personal debt, such as credit card balances and medical bills, and
- if your business debt exceeds your consumer debt, you can avoid the Chapter 7 means test.
The last factor is a great help to those who’ve moved on and are making a significant salary elsewhere. But remember that Chapter 7 isn’t always good if you own considerable property you’d like to keep. In that case, Chapter 13 might be best if you have assets you don’t want to give up.
A Sole Proprietor Can Discharge a Personal Guarantee
An exception exists for a sole proprietor who owns a business. Such owners are personally responsible for both individual and business debts. Therefore, a bankruptcy filing in the individual's name will include all obligations and nonexempt assets. As a result, a Chapter 7 bankruptcy will wipe out the underlying business debt and the individual liability under a personal guarantee.
Seeking Advice From a Bankruptcy Lawyer
If you’ve agreed to a personal guarantee that you can’t live up to, it’s advisable to have a bankruptcy attorney review your situation and help you plan the best course of action. You can learn how to maximize your initial consultation by reading Bankruptcy: Preparing to Meet with a Lawyer.