Questions
have been raised regarding a discharge in a business bankruptcy and the
recourse to a personal guarantor on a commercial debt which is discharged in
bankruptcy. In addition a question has
been raised as to the application of the automatic stay to the personal
guarantor when there is a bankruptcy filed by the corporate (or other
artificial entity). This blog is fortunate enough to be treated to a detailed answer to that inquiry by none other than Wanda Borges, whose credentials in this area of law are tremendous. Her contact information follows as well. Here is Wanda's take on the issue:
There
are several provisions in the Bankruptcy Code which address the issue of
discharge:
Bankruptcy
Code §727 says “The court shall grant the debtor a discharge, unless – (1) the
debtor is not an individual. It is quite
clear, therefore, that there is no discharge of a business which files a
chapter 7 proceeding. This makes perfect
sense because if a business files a Chapter 7 proceeding, it closes its doors
and no longer exists so there is no entity remaining that would benefit from
the discharge
Bankruptcy
Code §1141(d)(1)(A) provides that Confirmation of a Plan “discharges the debtor
from any debt that arose before the date of such confirmation…”
There
is no distinction in that provision between a chapter 11 of a corporate (or
other artificial entity) debtor or an individual debtor. Confirmation of a Plan bars creditors from
going after that entity for anything other than what the Plan provides.
Bankruptcy
Code §362 of the Bankruptcy Code
provides that any bankruptcy petition operates as a stay, “applicable to
all entities” of
1. the commencement or continuation of any
action against the debtor to collect or recover a claim which could have been
commenced prior to the filing of the petition
2. the enforcement against property of the
debtor of any judgment obtained before the filing of the petition
3. any act or action to obtain possession
of property of the debtor
4. any act or action to perfect a lien
against property of the debtor’s estate
5. any action to enforce a lien created
before the filing of the bankruptcy petition
6. any act to collect or recover a claim
that arose before the filing of the petition
7. any setoff of any debt owed to the
debtor that arose before the filing of the petition
8. the commencement or continuation of a
Tax Court proceeding concerning a tax liability for a period ending prior to
the filing of the petition.
Each
of these provisions is specifically aimed at the bar of any action against the
debtor which has filed a bankruptcy petition.
The
automatic stay does not prevent any action against the personal guarantor when
the artificial entity (i.e. corporation, limited liability company, limited
partnership, etc) files a chapter 7 or chapter 11 proceeding. Creditors are within their rights to proceed
to pursue the personal guarantor to collect the debt originally owed by the
artificial entity.
There
is an exception to this in the case of a Chapter 13 filing. Bankruptcy Code §1301 provides that “a
creditor may not act, or commence or continue any civil action, to collect all
or any part of a consumer debt of the debtor…” from a co-debtor. However, if this co-debtor became liable as
part of its own ordinary course of business (e.g. signed a promissory note
individually and not merely as a co-debtor), then the creditor is free to
pursue that debt. Notice also that this
only applies to consumer debts.
Be
aware, however, that although it is true that a personal guaranty will survive
an artificial entity/business chapter 7 proceeding and a chapter 11 proceeding
it has become commonplace for a chapter 11 debtor to include within its Plan,
an exculpation clause that effectively releases an individual guarantor. One must be extremely diligent when reading a
chapter 11 plan to be certain that it does not contain a release of the
guarantors. If the Plan does contain
that kind of exculpation or release language, a creditor should immediately
seek advice from a bankruptcy practitioner to determine if grounds exist to
object to that Plan.
Another
cautionary note is to be aware of a chapter 11 business which continues
operating after confirmation of its plan.
If you have a personal guarantor and a debt from a business exists on a
given date (e.g. $10,000 owing on 1/3/14), that guaranty survives the business
bankruptcy for that sum of money when the bankruptcy is filed after that
date. HOWEVER, I have seen cases where a
business chapter 11 has been filed so the personal guarantor's debt to the
creditor is $10,000 prior to the bankruptcy filing and then the business debtor
continues business operations AFTER the confirmation of a chapter 11 Plan. I would not rely on the personal guaranty
continuing in effect after the chapter 11 proceeding for new debt incurred by
the post-confirmation debtor.
There
is one final question raised which states "While the Bankruptcy Code looks
pretty clear in that the automatic stay pertains to debtors (not guarantors)
courts have started to jump on a catch-all in the code to support a broader
premise that the automatic stay should apply to non-bankruptcy guarantors of
corporate debt in some Chapter 11 situations. … the rationale of that approach
is that personal guarantors typically act as a source of funding for the
corporation and the preservation of their credit is instrumental in the
recapitalization process. Also, personal guarantors also typically manage the
corporation and having to defend themselves against debt collection action
distracts them from efforts to effectively operate and reorganize the debtor
entity."
Let
me address that scenario. Bankruptcy
Code §105 gives the Bankruptcy Judge broad equitable powers to do whatever it
takes to enable a chapter 11 to proceed towards confirmation of a Plan. Specifically, §105 states “The court may
issue any order, process, or judgment that is necessary or appropriate to carry
out the provisions of this title.” In
certain instances Bankruptcy Judges have expanded the automatic stay to cover
the principal(s) of a debtor when the court believes that the principal needs
that protection in order to properly run the business without having to fight
his personal creditors (those holding guaranties). A debtor must show extremely good cause in
order to get the Bankruptcy Judge to grant this expanded automatic stay protection. This was done in the Philadelphia Newspapers wherein the Bankruptcy Judge cited the
impact that a lawsuit against the principals would have on the debtor’s ability
to manage its reorganization process.
The automatic stay was extended also in the AH Robins case and in the Brier
Creek case. However, in each of
these cases and in any other case wherein the automatic stay is expanded beyond
the debtor, the circumstances must be such that would cause “adverse economic
consequences” to the debtor or some other “unusual circumstances” which would
warrant such expansion.
On
the other hand, we have recently been involved with a case in the State Court
wherein we sued two corporate entities who were the primary debtors, two
personal guarantors and a corporate guarantor.
The primary corporate debtors each filed chapter 11 proceedings. The State Court Judge would not let us
proceed with the litigation against the guarantors because the State Court
Judge said the automatic stay of the Bankruptcy Code prohibited him from
proceeding even against the guarantors. We
were compelled to file a motion with the Bankruptcy Court showing that the
automatic stay is not applicable to the non-debtor guarantors except in unusual
circumstances. Citing the AH Robins case as well as Calpine and other cases of note readily
persuaded Bankruptcy Judge Craig to issue an Order finding that the automatic
stay was inapplicable to the third-party non-debtor guarantors.
As
an aside, once the Bankruptcy Court Order finding the automatic stay to be
inapplicable was filed with the State Court, settlement discussions ensued.
WANDA
BORGES
BORGES
& ASSOCIATES, LLC
575
UNDERHILL BLVD., STE. 118
SYOSSET,
NEW YORK 11791
516-677-8200
x225
516-677-0806
fax
