Many small business owners personally guarantee their corporate debt. A Chapter 11 filing stops collection activities against the company, but what about the owners?
The Chapter 11 Co-Debtor Stay
The first place to look for bankruptcy protection is the Code. Unfortuantely the Bankruptcy Code does not provide for a co-debtor stay for Chapter 11 Bankruptcies. What that means is if a company files for Chapter 11 the filing does not automatically stop collection activies against a co-debtor (i.e. an owner with a personal guaranty). The Code does allow for co-debtor stays for Chapter 13 cases, so this exclusion was an intentional decision by Congress and not an oversight.
Protection through a 100% Plan
Some Chapter 11 Debtors have the financial ability to pay all creditors over the life of the plan, also known as a 100% Plan. Guarantors have used the 100% Plan as a defense in collection cases. Unfortunately, courts have rejected this defense. The Texas Court of Appeals looked at this in Hardwoods, Inc. v. Vanden Berghe, 917 S.W.2d 320 (Tex. Ct. App. 1996). The guarantor in that case attempted to avoid liability on a personal guaranty by raising a defense of accord and satisfaction (which is available as an affirmative defense in Missouri as well). This defense stated that because there was a Chapter 11 Plan which would pay the creditor, the debt was resolved and he should not be liable under the guaranty. The court rejected this defense stating that the Chapter 11 Plan can only protect the debtor and any discharge or payment of that debt affected the debtor and did not extend to the individual guarantors.
Protection by "sneaking one by"
Some courts have granted protection to a personal guarantor under the theory of res judicata or "issue preclusion." In those cases a debtor proposed a Plan that discharged both itself and a guarantor, the creditor did not object to the Plan, it was confirmed and the guarantor later filed a lawsuit against the guarantor. In those cases the Courts determined that the creditor, by failing to object to the Plan, waived its rights to pursue the guarantor. Basically a debtor "snuck one by" a creditor. This is a risky proposition because a Debtor is placing its hopes on the creditor making a mistake instead of making a sound legal argument.
Chapter 11 Plan with an individual injunction under 11 U.S.C. 105
As opposed to "slipping one by" a creditor, some debtors have proposed protection to a guarantor in their Chapter 11 Plans under 11 U.S.C. ?105. This is a proactive injunction request to the Bankruptcy Court Judge and not a proposed defense in the state case which would be determined by the state court judge. In this situation, if the Judge confirmed the Plan, all of its provisions, including the injunction, would be enforced in state court. This is different from seeking a co-debtor stay which must be done in its own separate adversary case; this is a protective injunction through the Plan. The Bankruptcy Court has the power under 11 U.S.C. ? 105 to protect guarantors through the confirmed Plan if it determines that 4 elements are present: (1) There is a danger of imminent, irreparable harm to the estate or the debtor's ability to reorganize; (2) There is a reasonable likelihood of a successful reorganization; (3) The court must balance the relative harm as between the debtor and the creditor who would be restrained; and (4) The court must consider the public interest; this requires a balancing of the public interest in successful bankruptcy reorganizations with other competing societal interests.
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