Why Small Business Failures So Often Trigger a Personal Bankruptcy

Personal Bankruptcy for Guaranteed Business DebtsI regularly meet with prospective clients who want to file a bankruptcy for their failing small business who believe that they themselves have little or no debt. Perhaps they own a small dry cleaner, convenience store, or retail store front. Given that I practice bankruptcy in Silicon Valley, many of these small business owners have other jobs as engineers, academics, or other professionals. Commonly, the owners of failing small businesses believed they did everything to shield themselves from the liabilities of their business by forming a corporation or LLC to operate the business and avoid personal liability for potential debts of the business. They never believed that if their business failed, this would necessitate a personal bankruptcy filing.

Unfortunately, these business owners did something early in the process of starting their business that they either took far too lightly or for which they did not appreciate the potentially disastrous consequences—they signed a personal guaranty for a business liability. Most often they signed a personal guaranty on a commercial lease, on a business line of credit, or when applying for a corporate credit card. By signing such a personal guaranty for a corporate or LLC debt, the business owner has forever agreed to be personally liable for that debt, in effect waiving the very personal liability protection that the corporation or LLC was intended to provide.

Personal guarantees on commercial leases can give rise to personal liability even after the owner has sold her business. Generally, whenever a business owner assigns a commercial lease as part of the sale of the business, he remains contractually bound as the original lessee, and as guarantor of the new owner’s obligations under the lease assignment. If the new owner breaks the lease, and say, files bankruptcy, the former owner can be sued by the commercial landlord for all rents due for the remainder of the lease term. Depending on the terms of the lease such liability can reach hundreds of thousands of dollars. Frequently, the former business owner retired after selling the business, never dreaming that he would remain liable for the rent if the buyer ran the business into the ground. Faced with such a debt, many such former business owners have little choice but to file personal bankruptcy.

Personal guarantees of business debts lead to personal bankruptcy with tragic frequency. In many cases the small business owner may avoid a subsequent bankruptcy by carefully avoiding guaranty clauses in leases and financing contracts. Although some commercial landlords may refuse to lease to a small corporation or LLC without a personal guaranty, this is a negotiable term, and it is possible to drive a harder bargain with the landlord and be prepared to walk away from a lease requiring one. Small business owners should understand that a personal guaranty is merely a shifting of risk between the lessor and lessee, and as such it should never be viewed as a fait accompli when entering into negotiations. Avoiding a personal guaranty today can help avoid a personal bankruptcy later if the business venture fails.

If you have small business debts resulting from a personal guaranty, you should contact one of our San Jose bankruptcy lawyers for a free consultation. If the majority of your debts are non-consumer debts, it may be easier for you to qualify for Chapter 7 bankruptcy, because you will not have to pass the Means Test.

This entry was posted in Bankruptcy in General, Personal Liability for Business Debts and tagged , , , . Bookmark the permalink. Both comments and trackbacks are currently closed.