Eric R. von Helms
Two years ago, this Newsletter discussed how the personal bankruptcy of a guarantor would affect the enforceability of that guaranty for debts incurred post-bankruptcy. The scenario we outlined was one where the guarantor of debt incurred by a business the guarantor owns files a personal bankruptcy, but does not disclose the personal bankruptcy to a creditor, while the non-bankrupt business continues to obtain goods or services from the creditor after the guarantor emerges from bankruptcy. Months or even years later, the business falls behind on its obligations to the creditor. In that situation, can the creditor pursue the guarantor for non-payment of post-bankruptcy debts, or did the bankruptcy render the guaranty null and void?
KMK obtained a definite answer to that question in a successful appeal to the United States District Court for the Eastern District of Wisconsin. Winning an important victory for our client, KMK successfully argued that the guaranty continues to be enforceable for post-bankruptcy debts. Further, the opinion sets important precedent for creditors in similar situations.
In an important opinion, In re Schlundt, 646 B.R. 478 (E.D. Wis. 2022), the District Court held that a guarantor’s liability under a pre-bankruptcy guaranty, for debt that arose from post-bankruptcy credit purchases, is not discharged by the guarantor’s bankruptcy.
In the Schlundt case, a restaurant business entered into a credit agreement with a supplier in 2003. The credit agreement was personally guaranteed by the sole owner of the business, David Schlundt, who provided a continuing guaranty for all present and future obligations of the restaurant to the supplier. Under the credit agreement, the restaurant made purchases on credit from the supplier for many years. Eleven years later, in 2014, Schlundt initiated a personal Chapter 7 bankruptcy, but failed to notify the creditor of his personal bankruptcy case. Both during and after his personal bankruptcy, Schlundt made purchases on credit from the supplier for his restaurant.
In 2018, four years after Schlundt received his discharge in bankruptcy, his restaurant failed to make payments when due. When the supplier made demand for payment on the restaurant as debtor and Schlundt as guarantor, Schlundt advised the supplier that the business was closed and that he had a discharge from the prior bankruptcy case.
The supplier, represented by KMK, returned to the Bankruptcy Court to reopen Schlundt’s personal bankruptcy case (rather than risking sanctions for pursuing a potentially discharged debt). On dueling motions for summary judgment, the Bankruptcy Court sided with Schlundt, holding that any obligations under the guaranty were discharged in Schlundt’s prior bankruptcy. However, KMK appealed the decision and obtained a successful ruling from the District Court reversing the Bankruptcy Court.
The crux of KMK’s successful argument was that, under Wisconsin law, a guaranty is a continuing offer to pay for the debts of another. Accordingly, each time a debtor purchases products on credit, Wisconsin law considers the guaranty of payment for each such purchase to be a separate transaction. For every purchase the restaurant made after Schlundt’s bankruptcy, Schlundt made new and separate offers to guaranty payment. Accordingly, the businesses purchases that occurred after Schlundt’s bankruptcy invoked new and distinct promises by Schlundt to guaranty payment, which did not arise until those post-bankruptcy purchases were made. Because those debts accrued post-bankruptcy, they were not discharged in Schlundt’s bankruptcy, and the guaranty remains enforceable with respect to the restaurant’s post-bankruptcy purchases.
The decision of the District Court could have a substantial positive impact on creditors that require personal guarantors of their credit agreements. Relying on the Schlundt decision, creditors in the Eastern District of Wisconsin (and other jurisdictions that find the court’s analysis here persuasive) can argue that guaranteed purchases made after a guarantor’s bankruptcy discharge remain enforceable and are not discharged.
While this adds a powerful argument that creditors can make to collect on debts, creditors should still remain diligent in ensuring that personal guaranties of credit agreements are enforceable. For instance, if a creditor hears rumors of a personal bankruptcy by the guarantor, the creditor should take appropriate steps to confirm whether such a bankruptcy filing has occurred. If the guarantor has in fact filed a bankruptcy case, the creditor should consider taking the protective measure of requiring a new guaranty covering future purchases as a condition for extending additional credit to the business. That was impossible in the Schlundt case, because the creditor had no notice of Schlundt’s personal bankruptcy until after the business had shut down. The best practice remains to review, thoroughly and periodically, the credit-worthiness of both debtors and guarantors, especially when a credit agreement is many years old. Being proactive on the front end will avoid significant heartache on the back end. That said, due to KMK’s efforts, a creditor who had no ability to protect itself from a guarantor’s unknown bankruptcy now has a strong argument that the guaranty remains enforceable.
Credit applications and guaranty forms should be reviewed regularly to ensure that they are consistent with developing law, and a creditor should also periodically review the agreements it has in place with debtors and guarantors. If you have any questions concerning your credit applications or guaranties, please contact KMK Attorney Eric Von Helms at email@example.com or (414) 962-5110.