The scenario is unusual but is becoming increasingly more common. A business enters into a credit agreement with a creditor to purchase goods or services. The creditor requires that one or more of the principals of the business provides a personal guaranty of the obligations of the business. The guarantors then file personal bankruptcy but decide to keep the business operating during and after the bankruptcy. The business is current with its obligations to the creditor at the time of the guarantors’ bankruptcy petition, so the guarantors do not list the creditor on their bankruptcy schedules. The creditor is not made aware that the guarantors are in personal bankruptcy.
Months or years later, the business falls behind in its obligations to the creditor. The creditor makes demand on both the business and the guarantors, based on the creditor not knowing about the guarantors’ prior bankruptcy. Upon learning about the bankruptcy of the guarantors, can the creditor still pursue the guarantors for the debt owed by the business?
The answer to this scenario has not been definitively answered by bankruptcy courts. Arguments can be made for both sides. On one hand, because the guarantors are discharged of all their pre-petition credit obligations, they would argue that this includes their pre-petition personal guaranties of the business. However, because the debt was incurred by the business post-petition, the creditor could argue such debt would not be discharged in the prior bankruptcy. Therefore, the question remains as to whether a guaranty of a business is discharged, in the guarantors’ bankruptcy, of all future post-petition obligations of the guarantors to the creditor.
Bankruptcy courts have taken different approaches when addressing the issue of whether the personal bankruptcy of a guarantor discharges the pre-petition guaranty. The Bankruptcy Court for the Middle District of Florida held, in In re Russo (494 B.R. 562, Bankr. M.D. Fla. 2013), that a claim arising from a guaranty arose when the pre-petition guaranty was made, not when the post-petition debt was incurred, and accordingly held the guaranty was discharged. The Court in Russo reasoned that the creditor could have required a new personal guaranty from the guarantor when providing new credit to the debtor business. Russo, 494 B.R. at 568.
The holding of the Court in Russo was not followed by the Bankruptcy Court for the Western District of Virginia in In re Shaffer, (585 B.R. 224, Bankr. W.D. Va. 2018). The Court in Shaffer held that because the guaranty of the guarantors was a continuing guaranty, and the guarantors did not revoke or terminate the guaranty, each new post-petition purchase was a distinct debt that arose post-petition and therefore was not discharged in the guarantors’ bankruptcy. 585 B.R. at 230.
In both Russo and Shaffer, there was evidence that the creditor received notice of the guarantors’ bankruptcies, but the creditors took no action as far as requiring the guarantors to reaffirm the guaranties. Neither court directly addressed the issue of what happens when the guarantors fail to notify the creditor of their bankruptcy. However, the Court in Russo found that a dispute of material fact existed as to whether the creditor received timely notice of the guarantor’s bankruptcy. If the creditor lacked notice of the guarantor’s bankruptcy, the Court reasoned, an argument could be made, under Section 523(a)(3) of the Bankruptcy Code, that the guaranty obligations were nondischargeable based on the lack of appropriate notice. The Court in Shaffer did not consider the issue of lack of notice to the creditor based on the Court holding that the debt was post-petition.
While this foregoing bankruptcy caselaw provides some support that the pre-petition guaranty survives the personal bankruptcy of the guarantor, the issue is not universally established. A creditor that proceeds against a guarantor, under a pre-petition guaranty, still risks the potential that a bankruptcy court may find that such action violated the bankruptcy discharge of the guarantor.
A Simple Solution
The creditor can seek a protective measure, to remove any doubt as to whether pursuing the guarantors’ results in a violation of the bankruptcy discharge, by obtaining a declaration from the bankruptcy court. The creditor can file a motion with the bankruptcy court, to reopen the guarantors’ bankruptcy, in order to obtain a declaration from the bankruptcy court that the pre-petition guaranty was not discharged. Obtaining such a declaration from the bankruptcy court will allow the creditor to proceed against the guarantors without the risk of potential costly sanctions for violating the guarantors’ bankruptcy discharge.
If you have any questions on this topic or other creditors’ rights matters, feel free to contact attorney Eric von Helms via email or call (414) 962-5110.
Founded in 1937, Kohner, Mann & Kailas, S.C. (KMK) is a leading law firm with a global reputation for success and a rich tradition of results, providing legal expertise in business and financial services, business litigation, and commercial collections. Recognized by U.S. News & World Report as one of the nation’s Best Law Firms, KMK is headquartered in Milwaukee, WI. For more information, visit www.kmksc.com.