Can You Settle Business Debt Without a Personal Guarantee? 5 Questions to Resolve

If the debts are not personally guaranteed, and assuming no other agreements exist, then the business can settle in its name without bringing the shareholder(s) into it. In general, creditors of a small business can only go after the business’s assets if the business owes them money, not a business owner’s personal assets, unless a valid personal guarantee was made. But there are a number of circumstances where a creditor could seek to collect a business debt by going after the personal assets of an owner or other person in control of a business.

Come After Business Owners Personally

If you are a sole proprietor you may be personally responsible for any business debt even if the creditor only has the company’s name on a contract. If the debt is only in the company’s name and you did not personally guarantee it or cosign on any promissory note, then an LLC will generally keep your personal assets safe from business creditors. But if you have personally guaranteed a debt, you are as much on the hook as if your business was a sole proprietorship, and a creditor can come after you and your personal assets if the business assets don’t satisfy the debt.

In the rush of events, it can be unclear if a signature at the end of a long lease or a loan document bound you personally. Read and reread the papers. A document guaranteeing someone else’s debt generally must be in writing and signed by the guarantor to be enforced. If you can find a document with your signature on it, the law may not care much if you were careless about reading the fine print.

If you have an SBA loan, watch out for the personal guaranty. In the case of a 7(a) loan, the SBA generally will require anyone owning 20 percent or more of your business to personally guarantee the loan. If that’s you, then the SBA can go after your personal assets if the business does not pay off the loan. In the case of the COVID EIDL loans, the SBA generally does not require a personal guaranty for a loan of $200,000 or less. If you signed a personal guaranty, neither closing your business nor putting it into bankruptcy will end your obligation. In the company’s bankruptcy, the court cannot generally force SBA to release a guarantor of a business debt.

A possible outcome to negotiating with the creditor can be a release from a guarantor’s obligation. The creditor will consider the negotiation’s terms - the amount to be paid over what period of time - compared to the amount it thinks it could collect against the guarantor. The creditor is likely to want something of value. If the guarantor contributes nothing, then what does the creditor gain by releasing the guarantor? Each co-signer will need a separate release.

In certain extreme situations a creditor can come after you personally, even without a personal guarantee. If a business owner treats the corporation as a private bank account for the owner’s personal bills, a court may decide to disregard the separate corporate entity and rule that the owner is personally responsible for the corporate debts. Likewise, a court can rule that an individual is personally liable for the debts of a corporation that’s undercapitalized when it was formed. This is known as “piercing the corporate veil.”

Pay the payroll taxes. If the IRS believes the failure to pay over withheld payroll taxes was intentional, it can hold the owner or other “responsible person” personally liable to pay what it calls the “Trust Fund Recovery Penalty”. This penalty is for the entire amount of the unpaid trust fund tax, not just a portion of it.

Negotiating Options

If you don’t have the ability to pay creditors in full, they may be willing to work with you. They may accept an arrangement where the debt is settled by paying less than what is currently owed. A creditor is likely to consider its negotiating options: what it could collect and when, weighed against how much it would cost to try to collect it. A creditor may prefer a sum of money it knows it will get over a debt it is unsure it can collect, even if that means getting paid less than what it is owed.

Keep in mind that the federal law for collection of consumer debts, the Fair Debt Collection Practices Act and Regulation F, does not cover business debt. The protections of those laws do not apply to your company.

The SBA has legal authority to compromise a debt or guaranty for less than the full balance of the debt. It is governed by Title 15 United States Code section 634(b). It is sometimes advisable to act before a loan is referred to Treasury.

An offer in compromise to the IRS from a business requires payment of an application fee of $205, plus payment of the first proposed installment. There is no low-income waiver of the application fee for businesses. If the business offers a lump sum, it must include payment of 20% of the offer when the application is filed.

Not all cases are solvable outside of bankruptcy. A Chapter 11 under Subchapter V is only available to a debtor whose total debts are no greater than $3,424,000. A Section 363 sale is a process where the debtor sells its assets under court supervision to pay creditors by priority; the purchaser buys them free and clear of liens. A secured lender gets the proceeds of the sale first, with anything unpaid to it becoming an unsecured claim subject to discharge or handling in the plan.

Debt Relief Can Trigger a Tax Liability

Getting a debt forgiven by a creditor is not always the complete solution. Debt relief can trigger a tax liability. If you have a discharged debt of $600 or more you will usually receive a 1099C form from your creditor at tax time. Normally, forgiven debt is treated as income. The IRS, however, may ignore this if you are insolvent, that is, your total debts exceeded the value of all your assets when the debt was forgiven. It’s not enough that the single-member LLC you own was insolvent; your own liabilities must exceed your own assets.

Once you work through these special cases, a debt only in the company name can usually be settled by the company. Check what entity, if any, is listed as the debtor. Also check for your signatures on the contract; have you signed in two capacities, once as the company and once as an individual? Have you paid over the withheld payroll taxes? Finally, if the debt is forgiven by the creditor in a settlement, consider the tax effect on yourself personally.