What Happens to a Personal Guarantee in Bankruptcy?

Learn how to eliminate a personal guarantee in bankruptcy.

By , Attorney

When you guarantee a loan for your business, friend, or family member, you make yourself liable for it. Luckily, you can usually wipe out your personal liability for debt through bankruptcy—including a personal guarantee entered into for your business. Read on to learn more about personal guarantees, including:

  • why people sign personal guarantees
  • eliminating a personal guarantee in bankruptcy
  • why bankruptcy won't get rid of most liens, and
  • how to decide between Chapter 7 or 13.

If you're a business owner, learn more about bankruptcy and small businesses.

What Is a Personal Guarantee?

A personal guarantee is an agreement that allows a lender to go after your personal assets if your company, relative, or friend defaults on a loan. For instance, if your business goes under, the creditor can sue you to collect any outstanding balance.

Why You Might Sign a Personal Guarantee

Most new companies don't have much in the way of assets. To increase the odds of getting paid, a lender will require a personal guarantee before extending a property loan or another obligation, such as a lease contract or extension of credit for goods. If the business fails, the lender has two remedies to satisfy an outstanding balance: It can go after the business assets if any, and your personal assets.

How to Eliminate a Personal Guarantee With Bankruptcy

It's relatively common for a business owner to file individual bankruptcy to get rid of a personal guarantee—and most personal guarantees will qualify for discharge. If it's a nondischargeable debt, however, bankruptcy won't help.

Also, keep in mind that filing on behalf of the business won't get rid of your personal obligation to pay back the guaranteed loan. In fact, in that situation, the personal guarantee will work against you. The trustee appointed to oversee the case will likely view the personal guarantee as a business asset and look to you and your assets for money to pay creditors.

Similarly, if you signed a personal guarantee for a friend or family member's loan, you'll still be on the hook if they file for bankruptcy. You'll have to file individual bankruptcy to get rid of the obligation. The exception is if the friend or family member pays off the debt in Chapter 13.

Liens Remain in Bankruptcy—Usually

Some personal guarantees include a security interest in your personal assets. In that case, the lender will typically have a lien on your property. A bankruptcy discharge will only wipe out your personal obligation to pay back debts—not the lien. The lien will allow the lender to foreclose on or repossess the collateral regardless of your bankruptcy discharge. Even so, remedies exist depending on the chapter type you file (more below).

Personal Guarantees in Bankruptcy Chapters 7 and 13

Each bankruptcy case is different. It's common to have a lot of moving parts and considerations, so it's best to meet with a bankruptcy attorney. In the meantime, here are a few things to consider.

Chapter 7 Bankruptcy

If you don't have much in the way of income or property—primarily debt—Chapter 7 will likely be your best option. You can wipe out (discharge) qualifying debt, such as credit card debt and personal guarantees, in approximately four months. If you have nondischargeable liability, such as a domestic support or tax obligation, you might be able to pay it over time by filing Chapter 13 immediately afterward. This strategy is known as Chapter 20.

Chapter 7 also works well if you have a substantial income, and the majority of your debt is business debt. Here's why. The means test prevents many people from filing for Chapter 7. However, when most of your debt is business-related as opposed to consumer debt, you aren't subject to the Chapter 7 means test income qualification. This can be a huge benefit for someone with a personal guarantee liability.

For instance, suppose that you still owe a significant amount of debt due to a personal guarantee from a failed business. However, now you're making a sizeable income working for someone else. You might be able to discharge your debt quickly using Chapter 7 despite a salary that would generally preclude you from filing. Assuming, of course, that you aren't concerned about losing property in Chapter 7. Find out if you're exempt from the means test.

In Chapter 7 bankruptcy, you might be able to avoid a nonpossessory, non-purchase-money lien. To qualify, the creditor can't have possession of the collateral, and you must have owned the asset before you pledged it as collateral. This applies only to certain types of property to the extent the lien impairs your exemptions. Exemptions are the laws that allow you to protect property in bankruptcy.

Nonpossessory, non-purchase-money liens can be avoided on assets such as tools of your trade, household goods and furnishings, jewelry, and professionally prescribed health aids. You can't avoid a lien on your house or car (unless the vehicle qualifies as a tool of the trade like a delivery truck).

Chapter 13 Bankruptcy

Many business people find this chapter helpful in several situations. You, as an individual, not the business, would be filing Chapter 13—companies can't file. Unlike Chapter 7, you can keep all of your property, and in most cases, you'll pay a smaller portion of your personal debt over time. Here are a couple of examples that illustrate how Chapter 13 can help.

  • You're still operating as a business, and you're worried you could lose the company if you file for Chapter 7. It's possible to improve your financial situation by getting out from under debt that you're responsible for paying individually, such as credit card balances and personal guarantees. Chapter 13 lets you spend less on that debt for three to five years, and wipes out qualifying debt after completing the Chapter 13 repayment plan. Some business people find this approach helps free up assets and in turn, keeps the business going.
  • The business is no longer operating, and you want to keep assets that you'd lose in Chapter 7. You can keep all property in Chapter 13. The tricky part is that you must pay creditors the value of your nonexempt property in your three- to five-year plan. But you'll eliminate all dischargeable debt through your repayment plan. Learn more about property in bankruptcy.

Chapter 13 has a few other benefits that aren't available in Chapter 7. If you're like many business people, you might have fallen behind on a house or car payment while trying to keep the company afloat. You can catch up on these payments through the Chapter 13 repayment plan and keep the home, car, or other secured property. You can also get rid of a wholly unsecured mortgage on your home using a lien strip, or reduce a 910-day old car loan balance.

Also, you might be able to reduce the amount you'd have to pay on some collateral through a cramdown in Chapter 13 bankruptcy. For instance, you can reduce the balance owed to the property's actual value on some personal property, or even a business or rental property. The catch is that you'd have to pay off the reduced loan amount through your plan.

Find out about the steps in a Chapter 13 case.

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