If you need a loan to start a business, chances are your lender will require you to sign a personal guarantee. Anytime you personally guarantee a loan (whether for your business, friend, or family member), you make yourself personally liable for it. Luckily, if your business fails, you can usually wipe out your personal liability for its debts through bankruptcy. Read on to learn more about how you can eliminate a personal guarantee through bankruptcy.
A personal guarantee is essentially a promise or agreement to make yourself personally liable for a debt. If you personally guarantee the debts of your business, your lender can go after the assets owned by the business as well as your personal assets if you default on the loan. If your business goes under and it doesn’t have enough assets to pay back the loan you guaranteed, the creditor can sue you to collect the remaining balance.
In general, most lenders will require a personal guarantee if you are starting a new business and the business doesn’t own a substantial amount of assets. Because the business doesn’t have a positive credit history yet, the lender will typically want you to personally guarantee the loan. This way, if the business fails, it can go after both business and personal assets to satisfy the loan. If your business can’t obtain a loan on its own, you may have no choice but to provide a personal guarantee to secure the necessary funding.
In most cases, you can easily discharge your liability for a personal guarantee by filing for bankruptcy relief (unless the guaranteed debt itself is nondischargeable). But keep in mind that you must file a personal bankruptcy to eliminate your personal guarantee. If the business files for bankruptcy, it doesn’t eliminate your personal obligation to pay back the guaranteed loan.
Similarly, if you signed a personal guarantee for a friend or family member’s loan, you are still on the hook if he or she files for bankruptcy but you don’t. If you discharge your personal guarantee through bankruptcy, the lender can no longer go after your personal assets to collect business debts. It is limited to the assets owned by the business.
Some personal guarantees may also include a security interest in your personal assets. In that case, the lender will typically have a lien on your property. A bankruptcy discharge only wipes out your personal obligation to pay back debts. It doesn’t eliminate liens. This means that the lender may still be able to foreclose on or repossess any of your properties it has a lien on regardless of your bankruptcy discharge.
If you pledged your property as collateral when you took out or personally guaranteed a loan, you may be able to avoid or reduce the lien through a cramdown or lien strip in Chapter 13 bankruptcy.
In Chapter 7 bankruptcy, you may be able to avoid nonpossessory (meaning the creditor doesn't have possession of the collateral), non-purchase-money (meaning you already owned the asset before you pledged it as collateral) liens on certain types of property to the extent they impair your exemptions. Nonpossessory, non-purchase-money liens may be avoided on assets such as tools of your trade (up to $5,575), household goods and furnishings, jewelry, and professionally prescribed health aids. Keep in mind that you can't avoid them if they are on your house or car (unless the vehicle qualifies as a tool of trade like a delivery truck).