Rich Man, Poor Man . . . Hurry Up, Man: Wash Away Personal Guarantees Quickly

Facing Personal Liability for Business Debts? Who Ya’ Gonna Call?¹

People who are not bankruptcy experts but who know something about the subject tend to put all bankruptcy attorneys into one of two buckets: (a) attorneys who help people file bankruptcy; and (b) attorneys who help businesses file bankruptcy. This distinction is mostly correct.

Generally speaking, there are two types of people who file bankruptcy: (a) people who incurred debt for personal or household purposes, which are “most people;” and (b) people whose debt derives from some form of business or investment, which are likely to be “wealthy people.”

Law is specialized…very specialized.

Bankruptcy attorneys who focus on representing individuals in bankruptcy typically represent most people (as defined above), rather than wealthy people (also defined above). Such attorneys are commonly referred to as “consumer bankruptcy attorneys.“ Most of these attorneys have never taken a company (or a person) through a chapter 11 bankruptcy.  Rather, they file chapter 7 and chapter 13 cases, and most of the debt for which their clients need bankruptcy consist of one or more of three types:

• Medical debt
• Student loan debt
• Consumer debt

 

Bankruptcy attorneys who represent businesses focus their practice on representing primarily businesses and their constituents. These attorneys are often referred to as “business bankruptcy attorneys.” Good business bankruptcy attorneys are also expert in the full menu of tools that a business can use to help address its financial problems. I’m referring here to out-of-court workouts and procedures such as assignments for the benefit of creditors (ABC) and “friendly foreclosure sales.”

Being an attorney is not rocket-science, but it does take study and experience. To do it well, it takes a lot of meaningful experience (you know that Malcom Gladwell thing, though, it has been discredited). And since there are only 24 hours in a day, most attorneys cannot be experts in many things. For these reasons, most consumer bankruptcy attorneys are not expert in business bankruptcy, and most business bankruptcy attorneys are not expert in consumer bankruptcies, or even in the bankruptcies of wealthy people.

So, what’s a wealthy person needing to file bankruptcy mostly because of business-related debts —or at least needing the advice of the sort of attorney who can help them decide whether bankruptcy is the right answer—to do? Bottom line, her due diligence.²

You Might be a Wealthy Person Needing Bankruptcy³

This article is for you if you own a business or a significant part of a business, you gave a personal guarantee (a “PG”), and your business operates one or more:

• Restaurants
• Brick and mortar retail stores
• Travel agencies, hotels, airlines, or any travel-related business
• Movie theaters, arcades, or any other entertainment venues
• Real estate parcels that lease out to any of the above
• Other of the tens of thousands of businesses hit hard by the pandemic or, for that matter, any other struggling business

 

Much of what I say here is also applicable to you if you are directly liable for business debts, though one of the key things I am trying to convey in this article is that if you have a PG, you may need to move faster than if you are the primary obligor on business debts.

What this Article is About

The executive summary is this:

1. Flesh and blood people can file chapter 11; it is not just for companies.
2. If you file chapter 11 and confirm a chapter 11 plan, you can wipe out most debt and potentially keep your property that you would have had to surrender if you had filed chapter 7.
3. Confirming a chapter 11 plan—at least a traditional chapter 11 plan—is difficult and expensive.
4. Subchapter V of the Bankruptcy Code was signed into law in August 2019, and it took effect on February 19, 2020. Oddly enough, it came just in time to help with the economic fallout of the COVID-19 pandemic.
5. Subchapter V created a new type of chapter 11, and confirming a Subchapter V chapter 11 plan is much easier and less expensive than confirming a traditional chapter 11 plan.
6. To qualify to file under Subchapter V of chapter 11, the would-be debtor must have less than a certain amount of noncontingent liquidated debt.
7. Until the pandemic hit, the debt cap was $2,725,625. Congress raised the cap to $7.5 million as part of the CARES Act, though that raised limit is currently slated to sunset on March 27, 2021.

 

Again, all of this applies whether you file personally for yourself or if your business files. If you want to read more about Subchapter V generally, then check out this article I co-authored, “Bankruptcy Code Revised.”  To see a chart comparing and contrasting a traditional chapter 11 case with a Subchapter V chapter 11 case, take a look at this handy chart drafted by a friend/partner of mine. If you are already thoroughly confused and could use a basic overview of what you, as an owner (or director, c-level executive, or board member) of a distressed company should know, then go to Financial Poise and download this free PowerPoint.

The Need for Speed #1 – Fitting Within Subchapter V

My concern, or rather your concern, should not be about the March 27^th sunset deadline.  Many people think the date will be extended, though that is not why you should be unconcerned about it. The reasons are less obvious, one of which is the $7.5 million cap, and one of which has to do with your ability to confirm a plan.

Part of the title of this article is “Wash Away Personal Guarantees- Quickly.” The word “quickly” is not intended to suggest that the process will be particularly swift (though it should be). Rather, what I am referring to is the need for you to pull the trigger on your personal filing quickly, before your personal guarantees are triggered.

Take a step back. To elect to be treated under Subchapter V, you must (as explained above) have no more than $7.5 million non contingent, liquidated liability on the day you file your chapter 11 petition.

If you are like many successful business owners, you have given personal guarantees in a variety of contexts to a variety of creditors, such as banks, landlords, and anyone who demanded one and had the leverage to get one from you.

That liability could easily exceed $7.5 million. But guess what? Until your company defaults under the debt you guaranteed, the claim the counterparty has against you is contingent. And even if there has been a default, the claim still may be unliquidated. Also, debt owed by any of your affiliates that are in bankruptcy count toward calculating the $7.5 million cap. So, if the company you own files first, that may itself push you right over the cap, thus making you ineligible for Subchapter V.

So, if you are going to need to file, you may be materially better off by filing sooner rather than later. Thus, one reason for the need for speed.

The Need for Speed #2 – Confirming a Plan Under Subchapter V

Assuming you file your personal chapter 11 under Subchapter V, you will, again, enjoy many benefits as compared to if your case was not under Subchapter V.  Notably, many of the hoops you must jump through with (i.e., requirements of) a traditional chapter 11 plan simply do not apply to a Subchapter V plan. There is one that may be materially easier for you to satisfy if you are able to move faster rather than slower. I’m talking about Bankruptcy Code §1129(a)(7).

Section 1129(a)(7) of the Bankruptcy Code provides that each holder of a claim or interest in an impaired class of claims or interests must accept the plan or, if such holder does not accept, then the court must find that such creditor “[w]ill receive or retain under the plan on account of such claim or interest property of a value, as of the effective date of the plan, that is not less than the amount that such holder would so receive or retain if the debtor were liquidated under chapter 7. . . .”

To be clear, if your business is in the toilet at the time of confirmation of the plan in your personal bankruptcy, then it will be far easier for a court to find that what your plan will pay to any particular holder of a claim against you is at least as much as that claimholder would get if your case converted to chapter 7. Why? Because a chapter 7 trustee could be reasonably expected to sell your (former) equity in your company for very little.

[Author’s Note: As the disclaimer on the DailyDAC website states, you should not make any decisions based on this article, other that the decision to consult with your attorney. While I am an attorney (and a darn good one at that), I am not your attorney (though I could be). Also, every situation is different and even a small change in the facts can lead to a very different result.]

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[Editors’ Note: If this article is helpful, consider subscribing to Opportunity Amidst Crisis, A tour guide for business owners & investors, of the offensive & defensive use of business bankruptcy & its alternatives. You may also want to go here and download a free PowerPoint that was used in the Opportunity Amidst Crisis Webinar.

You may also want to attend the following webinars: The Nuts & Bolts of a Chapter 11 Plan, Help, My Business is In Trouble! And Opportunity Amidst Crisis.]

Footnotes: 

1. I am indeed a child of the 80s. The sequel to the book, Ready Player One will be out very soon. It will be a while until it is made into a movie, and then it remains to be seen how many movie theaters will still be in business by then.

2. I intend this mostly as a rhetorical question, though the answer is to simply do your due diligence—but not like you might compare two hotels for a short vacation or two restaurants for an upcoming dinner. Think more like how you would approach finding a surgeon for a life and death operation. While I don’t mean to be solicitous, but this article from my own law firm’s website should be helpful.

3. Just an homage to the comedy stylings of Jeff Foxworthy.

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