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Business Owner Guarantees and Bankruptcy

by | Jan 20, 2022 | Bankruptcy, Bankruptcy, Debt, Business

By: Dean A. Langdon

DelCotto Law Group has many small business owners as clients. When a small business borrows funds, the lender often requires a personal guarantee from the business owners. A recurring issue is what happens to the guarantee if a business falters or fails. A recent case from Louisiana shows how bankruptcy law can help solve this dilemma. Here’s how the Fifth Circuit Court of Appeal described the situation:

A grocery went bankrupt. One of the store’s creditors filed a proof of claim for about $325,000, the balance on a loan it had made to the grocery. In the business’s Chapter 11 plan, the bankruptcy court awarded the creditor the grocery store and the land where it was located. The court assessed the value of this property at $225,000. The plan thus reduced the outstanding balance on the loan to $100,000.  The couple who owned the grocery business had guaranteed the loan, so they remained liable but only for the remaining balance. (New Falls Corp. v. LaHaye (In re LaHaye) Case 19-30795, Fifth Circuit Court of Appeals)

The lender chose not to take the grocery store back as it had declined in value and filed suit against the owners to recover the total loan balance. That caused the owners to file a bankruptcy of their own. Undeterred, the lender filed a claim against the owners for the full amount of the loan – more than the initial $325,000 by now. The lender argued that the business’s bankruptcy plan only limited their rights as to the business – not the guarantors – and that the guarantors could not be released under bankruptcy law.

The bankruptcy court initially agreed with the debtors that the lenders’ claim was limited to the $100,000 left after the business’s bankruptcy. Unhappy with the result, the lender appealed. The Court of Appeals agreed with the bankruptcy court, reasoning that the bankruptcy plan of the business did not release the guarantors, it just reduced the amount they owed.  As the court explained it, if the business plan provided to pay the lender $250,000 instead of turning over the grocery store, there would be no question the guarantors would just be liable for the remaining $100,000 and that bankruptcy law treated these circumstances the same way. The fact that the lender chose not to take the store back did not change the rights of the parties, which were clearly set forth in the business’s bankruptcy plan.

Each case is different, and this approach may not work in every situation. But it is a good example of thinking ahead and using the bankruptcy process to protect business owners in times of financial distress. This is the type of situation the lawyers at DelCotto Law Group help businesses (and business owners) with on a regular basis. Should you find yourself in this situation, we would be happy to assist you.

About DelCotto Law Group

DelCotto Law Group is Kentucky’s asset preservation and business restructuring law firm known for its commitment to the lifetime success of its clients. With offices located in Lexington, Louisville and Danville, DLG serves Kentuckians with complicated financial matters, especially in the areas of bankruptcy and complex litigation. For more information please call (859) 231-5800, email [email protected] or reach us on our contact page.