Commercial Debt Relief: 5 Obligations That Need Separate Treatment

Each Obligation Needs Its Own Plan

Many owners think debt is just debt, and it all gets paid or ignored the same way. Not true: it can be more complicated than it looks. Each obligation needs its own plan. Personally guaranteed bank and SBA loans, commercial leases, merchant cash advances, unpaid payroll taxes, and equipment leases can require unique strategies. (Did you know that an LLC may not protect you once you sign a personal guarantee?)

Companies structured as LLCs and corporations protect owners from creditors’ collections (in other words, limited liability) for companies’ debts. If a business fails, banks and trade vendors aren’t allowed to attack owners’ personal assets. Not so when a personal guarantee is required to open a business credit line or sign a lease. In most cases, if you sign a guarantee, your personal assets are exposed. When you sign a personal guarantee, bankruptcy for the company doesn’t protect you from personal collections, and the bankruptcy trustee cannot wipe out that guarantee. A personal guarantee is a promise to personally pay.

Creditors can go after personal bank accounts, wages, property, and even non-exempt real estate and investments. The owners of one bar were left with a $610,000 bank loan, a $110,000 merchant loan, $50,000 in credit cards, and a $26,000 a month lease, all of which they personally guaranteed.

Most SBA loans require a personal guarantee from every owner with 20% or more interest in the company. COVID EIDL loans, under the CARES Act, required a personal guarantee from every owner with a 20% or more interest when the loan is more than $200,000. If there’s a default, SBA usually reimburses the lender, and the government itself becomes your creditor. Once it does that, the debt may be sent to the Treasury for collection, and the government can seize your tax refunds or garnish your wages. Interest, penalties and collection fees can be added to the balance once it’s with Treasury. If you have a government-backed (SBA) 504 loan, you may be able to settle it for less with an Offer in Compromise after the lender has sold off collateral.

Another common form of personal guarantee is for commercial leases. Landlords are often loath to sign small businesses without getting some protection. If the business closes with years left on the lease, the landlord may be able to sue the guarantor personally for the whole remaining balance. One example: a preschool owner faced more than $330,000 in lease arrears. The owner also guaranteed the company’s SBA loan. Sometimes, filing a personal bankruptcy can wipe out those personal guarantees. Your lease has its own clock when you file business bankruptcy: it needs to be assumed or rejected within 120 days of filing. Bankruptcy courts can extend that 120-day deadline. If you don’t meet that deadline, the court will assume you’ve rejected it, and you need to clear out immediately.

Merchant cash advances are another source of personal guarantees. Providers often demand personal guarantees and liens on assets when they loan to a company. Sometimes there’s a daily ACH withdrawal from the operating account to pay off the balance. That can saddle owners with a severe, constant cash crunch, making it very difficult to pay vendors and make payroll. Some owners open a second advance to cover payments on the first, and take a third to cover the second and so on, each time adding to the debt. MCA contract terms do matter. New York courts weigh three factors to decide if an advance is really a loan that could be usurious: whether the contract requires reconciliation of the “purchased” receivables, whether the term is finite, and whether the provider has recourse if the merchant goes bankrupt. Since 2019 in New York, county clerks cannot enter confessions of judgment against out-of-state debtors.

Unpaid payroll taxes are very different from debts from personal guarantees. The IRS doesn’t need a personal guarantee to go after you. It can assess against the responsible person, such as an owner or officer who directs payments, a penalty equal to 100% of the trust fund taxes that weren’t paid if the failure was willful. You have 60 days from the date of the IRS letter to appeal this penalty.

Equipment leases need a careful review. A lease that you can’t cancel might be treated like a secured loan. If you can buy the equipment for a nominal or no payment at the end, or if the term lasts for the equipment’s remaining economic life, that could mean the lease is really a loan.

Personal Guarantee Exit Strategy

Get clarity on what you owe on each debt. Calculate the balances. Find out if there’s a personal guarantee, a lien, or if you’re jointly liable. Some debts requiring personal guarantees can be resolved without the business needing to file bankruptcy. Negotiated settlements, structured repayment, creditor workouts, and asset sales are all tactics that can work, but different guarantees have different personalities. If you’ve been sued and the creditor gets a judgment against you, you may be at a serious disadvantage. Never move assets or create new entities without getting legal advice first.

If bankruptcy is needed, it matters what chapter of the bankruptcy code you file under. A personal Chapter 7 can discharge most personally guaranteed business debts, and is often best when the business is shutting. Chapter 11, the reorganization bankruptcy, now includes Subchapter V, which lets a viable business restructure, but guaranteed debts aren’t automatically eliminated. Before going bankrupt, you need to develop a personal guarantee exit strategy. Fraudulent transfers and preference payments could create a nightmare. Owners often close the entity, file personally to eliminate the guarantees, start a new business after discharge, but should structure it properly.

Cancellation of Debt

Caveat: settling debt for less has a tax side. If the lender cancels $600 or more of debt, it files a Form 1099-C Cancellation of Debt with the IRS. That debt is usually considered taxable income unless you can show an exclusion like insolvency applies, which is reported on Form 982.

With proper planning, many owners have gotten rid of their most overwhelming guarantees and some restart new businesses later.