Before You Personally Guarantee a Business Loan, Read This

Most small businesses owners have borrowed money to start and grow their businesses and, in most cases, had been requested by the lender to personally guarantee those debts. Sometimes the lender also requires the spouse to guarantee the debt, even if the spouse has nothing to do with the business.

In a loan context, a guarantee is a promise to pay the debt if the borrower is unable to do so.

In a business loan context, a personal guarantee is the promise of an individual, often the business owner, to pay the debt if the business is unable to do so.

Why is it important to pay attention to these personal guarantees?

Because starting and growing a small business is risky. If the startup fails, the personal guarantor is on the hook for those debts. All of the guarantor’s assets can be seized by the creditor once it obtains a judgment against the guarantor.

Why is it important to pay attention to a request that the spouse guarantee the debt?

Because when in Missouri a husband and wife own an asset together, such as a home or joint bank account, it is said to be owned as “Tenants by the Entirety” or TBE. In Illinois, TBE ownership is limited to homes owned by married couples.

TBE ownership is different than joint ownership. If two owners of an asset aren’t married, creditors of only one owner can reach that owner’s interest in the asset. With TBE ownership, however, only creditors of both owners can reach the asset. Obviously, it is to the business owner’s advantage not to have the spouse on the guarantee. This prevents the lender from seizing the jointly owned asset should the business fail.

Federal law protects a lender from demanding a spouse’s signature unless the spouse is a partner, director, or officer of the business or a shareholder or member. Regulation B, a provision of the Equal Credit Opportunity Act, provides that a lender cannot demand the signature of a spouse who is not involved in the business if the applicant qualifies for credit without the spouse’s guarantee and the spouse is not a joint applicant. Before your spouse signs any loan documents, be sure to consult with your attorney to ensure that a spousal signature is not required.

Should your business fail, and the lender tries to enforce the guarantee, your attorney should review the loan documents to determine if you have any defenses to the guarantee. For instance, a lender cannot enforce an “embedded guarantee,” in which some provision in the loan document itself states that the owner’s signature as a representative of the borrower also serves as a personal guarantee of the loan personally. These are not enforceable.

Because of the risk inherent in signing a personal guarantee, a separate individual signature underneath the terms of the guarantee is required for the guarantee to be effective. This can be either in a separate portion of the loan document or in a stand-alone guarantee document.

Can I limit my risk under a personal guarantee? Continue reading »

Getting Through Chapter 11 – Part Two: Plan of Reorganization

Part 5.2 of a 5-part series: Options for Small Business Owners in Financial Distress

Your company’s Chapter 11 bankruptcy has been filed and you’re now running your business under the provisions of the United States Bankruptcy Code.

It’s now time to work toward the ultimate goal of a Chapter 11: a Plan of Reorganization, confirmed by the court, allowing your company to restructure its debts, exit Chapter 11, and continue in business. It is important that you explain all of your concerns about all aspects of your business to your attorney and provide complete and accurate information, all before you even file the case. This will help both of you develop good ideas for successfully navigating your reorganization case and getting a plan confirmed. Advise your attorney if a new problem develops so you can consider all the potential solutions available to you.

Your next steps in planning for reorganization will include you and your attorney:

• Participating in two mandatory meetings with a U.S. bankruptcy trustee within the first 30 days after filing and begin filing monthly operating reports.
  1. “Initial debtor interview:” Learn procedural issues such as the ins and outs of filing periodic operating reports such as monthly operating reports and where and how your company can bank.
  2. Section 341 “meeting of creditors:” Be questioned under oath by the U.S. trustee’s office about your need to file Chapter 11, your plan to exit bankruptcy, how you will implement your ideas, etc. This meeting is open to all interested parties.
• Negotiating the terms of your proposed plan with the creditors’ committee if one has been formed by large unsecured creditors.
• Negotiating lease terms. Any lease which commenced prior to the filing can be “rejected.” You can then renegotiate the terms or terminate the lease, in which case the lessor’s claim will be treated as a pre-petition claim.
• Treating an equipment lease as an installment purchase agreement secured by the equipment, possibly converting a portion of the secured debt to unsecured and altering the terms of repaying the secured debt.

Continue reading »

Getting Through Chapter 11 – Part One: After Filing

Part 5.1 of a 5-part series: Options for Small Business Owners in Financial Distress

Your attorney has just filed your company’s Chapter 11 reorganization case and you have no clue what to do next. Seriously, the first thing you should do is nothing. Take a breath and keep running your business.

That’s not to say there’s nothing for you to do during the entire Chapter 11 process – there’s actually quite a lot for which you will be responsible. Any competent bankruptcy attorney already has discussed your statutory and practical responsibilities in a Chapter 11 case with you prior to filing.

Now is the time to implement those decisions made before the case was filed. If you forget a decision you made (or come across an issue you hadn’t discussed), call your attorney. The two of you should be in frequent contact during the case to be sure that you don’t take any actions which don’t make sense in the Chapter 11 context, or which might violate the Bankruptcy Code, Bankruptcy Rules, or Local Rules.

Your primary concern after the case is filed is, of course, money to operate with. That topic should be discussed thoroughly with your attorney prior to filing. Be sure your attorney discusses post-petition financing and use of ‘cash collateral’ with you. Be sure that you have post-petition financing lined up before you file, either from internal operations or from a lender. If your post-petition financing falls through, or you’re not as profitable as you expected to be after filing, you may not be able to afford to operate during the Chapter 11. If so, there is  no way for you to reorganize and your Chapter 11 case may be dismissed outright. Continue reading »

Can Real Estate Property Lost Due to Unpaid Taxes Be Recovered Through Bankruptcy?

Every state has a statute authorizing the counties within it to foreclose on or sell real estate which has delinquent taxes owed on the property. In Missouri, for instance, counties are allowed to conduct sales of such properties once the real estate taxes have been delinquent for three years. The exact procedure may vary from county to county.

The purchaser at a tax sale will likely pay much less than the property is worth. If the previous owner should file a bankruptcy case, can the bankruptcy court set aside the sale as “fraudulent,” in the sense that the property was transferred from the owner for less than the true value of the property?

In 1994, in BFP v. Resolution Trust, 511 U.S. 531, the U.S. Supreme Court ruled that properly conducted mortgage or Deed of Trust foreclosures cannot be fraudulent transfers because, although it is very rare for a foreclosure sale price to be anywhere close to a market price, notice of the sale is published and members of the public can attend the sale and purchase the property if they care to.

However, the fraudulent transfer question is much closer if the transfer is by tax sale. The notice of the sale is narrower than even a mortgage foreclosure, and the chances of the property selling for a fair value is even less.

So, can a sale or foreclosure for delinquent taxes be set aside as constructively fraudulent? This question has given rise to a split among the Circuits. The Sixth Circuit, in the recent case of Lowry v. Southfield Neighborhood Revitalization Initiative (In re Lowry), 20-1712 (6th Cir. Dec. 27, 2021), found that the BFP reasoning did not apply to tax sales. This brought the circuit split even, with three circuits (the Fifth, Ninth and Tenth) finding that BFP does apply to tax sales and three circuits (the Third, Sixth and Seventh), holding that it does not.

The Bottom Line: Continue reading »

Bankruptcy Options for Your Troubled Small Business

Part 4 of a 5-part series: Options for Small Business Owners in Financial Distress

If you’re a small business owner in financial distress, you’re undoubtedly looking for options for your business to have a better chance of surviving the pandemic and other economic surprises of the recent year. In the first three parts of this five-part series, we’ve looked at ideas for improving your business operations, discussed the importance of the availability of cash and improving your cash flow, and reviewed non-bankruptcy options to restructure your debts.

However, you and your attorney may conclude that none of those options meet your needs and it is time to consider a formal bankruptcy filing under the U.S. Bankruptcy Code.

Forms of Bankruptcy Relief

Before getting into details, let me make a suggestion: Don’t be too hard on yourself. It is rare for a business to fail because of only one issue. Even if your actions contributed to the problem, there were most likely other factors beyond your control involved as well. Besides, bankruptcy may provide a chance for you to fix what went wrong.

Another consideration is that the old stigma of filing a bankruptcy case has largely dissipated over the past few decades. Our Founding Fathers realized that the old European use of a debtors’ prison was unworkable and that a structured mechanism to help financially strapped people and businesses navigate a “soft landing” was needed instead. As a result, there actually is a provision in the U.S. Constitution requiring the Congress to make “uniform Laws on the subject of Bankruptcies throughout the United States.”

If you feel embarrassed about filing a bankruptcy, compare it to taking a tax deduction. It’s another example of financial relief provided by statute to individuals and businesses. It’s there for you to use, and there’s no reason to feel guilty for doing so.

The Bankruptcy Code provides for several different types of bankruptcy filings: Continue reading »

Non-Bankruptcy Ideas for Helping Your Troubled Small Business

Part 3 of a 5-part series: Options for Small Business Owners in Financial Distress

In the first two parts of this five-part series on options for small business owners in financial distress, I suggested some ideas for improving your business operations and the availability of cash so that your small business would have a better chance of surviving the pandemic and other economic surprises of the recent year. In this Part 3, I suggest some ideas on using non-bankruptcy options in an effort to restructure your debts. We will discuss several bankruptcy options in Part 4.

Non-Bankruptcy Options for Restructuring Your Debt

1. Informal Workouts

If your business has 1) maintained good relationships with its creditors, especially its primary lenders, and 2) doesn’t have too many creditors, it may be able to work itself out of its financial troubles. Secured creditors, of course, must be treated with full respect for their security interests in the business assets. Unsecured suppliers of critical goods and services also must be treated with care, as their cooperation may be needed at some point in the future.

It is often useful to obtain an appraisal of your business assets, both real and personal, from well-respected appraisers experienced in their fields. The appraisal should value the assets at three levels: forced liquidation value, orderly liquidation value, and fair market value. These values will enable you to intelligently discuss the likelihood of collection in different situations.

Another useful action would be to hire a consultant. Sometimes business owners cannot see opportunities for improvement which are right in front of them simply because they think that the current practice works well. The consultant can help you review your company’s operating procedures, cash flow procedures, and pricing structure to look for opportunities to increase profitability. Continue reading »

Financial Relief for Your Troubled Small Business Clients

It’s no secret that many small businesses are facing financial troubles these days, not only because of the COVID-19 pandemic, but also because of the rapid and unpredictable twists and turns of the current economy. This article will discuss, in two parts, the various ways in which a financially troubled business can seek financial relief, ranging from informal negotiations and state statutory remedies to filing a Chapter 11 reorganization bankruptcy case, so that attorneys can provide general assistance to their small business clients, or refer them to an insolvency attorney if appropriate.

Part I: Negotiations and State Statutory Remedies

Informal Workouts

If a debtor is on good terms with its creditors, especially its primary lenders, it may be able to earn itself out of its financial troubles. The secured creditors, of course, must be treated with full respect for their security interests in the assets of the debtor. Unsecured suppliers of critical goods and services also must be treated with care, as their cooperation may be needed at some point in the future.

It is often useful for a debtor to obtain an appraisal of its assets, both real and personal, from well-respected appraisers experienced in their fields. The appraisal should value the assets at three levels: forced liquidation value, orderly liquidation value, and fair market value. These values will enable the debtor to intelligently discuss the likelihood of collection in different situations.

Another useful action would be to hire a consultant. Sometimes business owners cannot see opportunities for improvement which are right in front of them, simply because they think that the current practice works well. The consultant can help the owner review the company’s operating procedures, cash flow procedures and pricing structure to look for opportunities to increase profitability.

The consultant also could prepare projections of future profitability for the company, based upon the opportunities which are discovered. Armed with the collateral valuations and projections, the owner can show the company’s creditors a plan for solving its problems.^[1] That is much more effective than simply asking for more time or engaging in stalling tactics.

Statutory Remedies

1. Assignments for the Benefit of Creditors

Continue reading »

Accumulating Cash and Improving Your Business’ Cash Flow

Part 2 of a 5-part series: Options for Small Business Owners in Financial Distress

Cash is how your business likely will get through its difficulties. Simply put, obtain as much cash as you can, and spend it sparingly.

In Part 1 of this five-part series on options for small business owners in financial distress, I suggested some ideas about improving the operation of your small business in order to survive different types of disasters. In Part 2, I’ll share some thoughts on improving your cash position and cash flow.

First, look at your business as a source of cash.

• Account receivables: Contact your customers with outstanding account receivables and encourage them to make payment. Provide discounts for prompt payment and charge interest on past due amounts if you can.
• Line of credit: If you have unused room on a line of credit, draw on it now while you still can. If things get bad enough, your lender might freeze your line and cut off further draws.
• Business loan: If you need to approach a lender for a new loan or an increase in an existing one, do your homework. No lender is going to give you money just because you ask for it.
• Business plan: Prepare a business plan or update your current plan to reflect current conditions. You may need help from your accountant, attorney, consultant or similar outside sources in order to do so. Your plan may include both a “needs” list and a “wants” list.
• How much? Determine how much money you need to implement your plan whether your business plan is to simply tread water, grow, or pivot in another direction. Break it down so your potential lender understands how it is going to save your business.
• How to pay it back? Once you have a rough number, consider how you’re going to repay it. Your business’ survival depends in part on its ability to pay its debts. Consider both the amount and duration of the likely payments.
• Avoid “hard money” lenders: When looking for lenders, be very careful to avoid “hard money” lenders and their draconian interest rates and repayment schedules. These can include factoring companies who purchase your receivables, MCA lenders who say they are “purchasing” your accounts receivable but in reality are lending against them, and other types of lenders with outrageous interest rates and impossible repayment terms.

Continue reading »

Your Small Business: Getting Through the Economic Turbulence

Part 1 of a 5-part series: Options for Small Business Owners in Financial Distress

Suppose your small business has been doing fairly well over the last few months in spite of COVID-19 and the many other factors affecting our economy. However, you are worried about the upcoming change of seasons, additional shutdown orders, or other circumstances which might adversely affect it.

Or suppose you expect to do well over the holidays even in the face of (or because of) the pandemic, but dread your normally slow months of January, February, and March.

Or suppose you recently undertook a large project which fell apart and left you owing a ton of money.

Different situations require different responses.

Specific Event

If a specific event led to your problems, but your business is otherwise profitable, you may be able to work out of them.

Equipment Problems

Imagine that your business was doing so well that you bought additional equipment and hired additional employees in order to meet the demand.

Unfortunately, your new equipment didn’t work as promised. Rather than the promised six weeks, the new equipment took a year to get up and running smoothly. In addition to failing to fulfill all of your orders during this time, you paid employees overtime to produce as much as they could despite the distractions caused by the equipment problems. Continue reading »

Options for Small Business Owners in Financial Distress: A 5-Part Series

Many small business owners are suffering financially due to the effects of COVID-19 and the unpredictable, rapidly changing economy in general. In this five-part series, we will discuss the various options available to small businesses in financial trouble, all the way from working out obligations informally to Chapter 11 reorganization to going out of business.

The series will cover the following issues:

• Introduction: Options for Small Business Owners in Financial Distress: A 5-Part Series
• Part 1: Your Small Business: The Economic Turbulence – Analyzing and improving your business operations
• Part 2: Accumulating Cash and Improving Your Business’ Cash Flow – Analyzing and improving the business’ flow, as well as obtaining additional financing if necessary
• Part 3: Non-Bankruptcy Ideas for Helping Your Troubled Small Business –  Ideas on using non-bankruptcy options in an effort to restructure your debts
• Part 4: Bankruptcy Options for Your Troubled Small Business – Pros and cons of various types of bankruptcy
• Part 5.1. Getting Through Chapter 11 – Part One: After Filing – Getting through a bankruptcy case and coming out on the other side
• Part 5.2: Getting Through Chapter 11 – Part Two: Plan of Reorganization – Putting together your plan for reorganization and confirmation by the bankruptcy court

Continue reading »