An Unconditional and Irrevocable Personal Guaranty Not Always the Case When a Bankruptcy Court Is Involved
On Aug. 19, the Bankruptcy Court for the Eastern District of Wisconsin issued a decision that serves as a warning and a reminder for business and individuals alike who obtain personal guarantees as part of their business dealings. Indeed, an unconditional, absolute and irrevocable personal guaranty may not be so after all.
The facts of the case are relatively straightforward: David Schlundt was the owner of a restaurant in Antigo, Wisconsin, and, in September 2003, caused the restaurant to enter into a supply agreement with a food service provider. The agreement also included a personal guaranty by Schlundt, guaranteeing prompt payment of any obligation of the restaurant to the provider. Specifically, the guaranty provided that Schlundt “personally guaranteed prompt payment of any obligation of the [restaurant] … whether now existing or hereinafter occurred” and that it was “understood that this guaranty shall be an absolute, continuing and irrevocable guaranty for such indebtedness of the [restaurant].”
Nearly 10 years later, Schlundt and his wife jointly filed a Chapter 7 (liquidation) bankruptcy case. The Schlundts did not list the food service provider as a creditor, even though the restaurant may have owed the supplier approximately $10,000 at the time of the bankruptcy filing. Because the bankruptcy trustee ultimately determined that the Schlundts did not have any assets available for liquidation, no deadline was ever set for creditors to file proofs of claim, and in April 2014 the Schlundts received a discharge of their debts.
During the Schlundts’ personal bankruptcy case, the food service provider continued to operate and work with the restaurant under the terms of the 2003 agreement. At the end of 2019, though, the food service provider filed a motion to reopen the bankruptcy case so that it could initiate an adversary proceeding and obtain a declaration from the bankruptcy court that the discharge the Schlundts’ received did not include a discharge of the personal guaranty. Indeed, the food service provider wanted to ensure that it would not be violating the discharge injunction by filing suit in state court over $50,000 in unpaid invoices and attorney fees for upon goods delivered between March 2018 and May 2018. In response, the Schlundts argued that any personal guaranty that existed under the 2003 agreement was discharged and extinguished when he received his Chapter 7 discharge.
In considering the issues, the bankruptcy court’s decision turned on a seemingly simple question: Whether the individual personal guaranty signed by Schlundt in 2003 created a pre-petition debt that was then discharged in his bankruptcy, or did it set the stage for a post-petition debt that was not incurred until the food service provider extended the credit in 2018. This is because Section 727(b) of the Bankruptcy Code discharges debtors from “all debts that arose before” the bankruptcy was filed. The court’s reasoning and ultimate decision, however, were more nuanced.
The bankruptcy court first looked to the language of the Bankruptcy Code, itself. The court noted that the term “debt” means liability on a claim, and that a “claim,” in turn, means “a right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.”
Next, the court recognized that, in determining whether a claim arose pre- or post-petition, the U.S. Court of Appeals for the Seventh Circuit (which was the appellate circuit in which the Schlundt case was pending) had adopted the “conduct test,” which provides that the date of a claim is determined by the date of the conduct giving rise to the claim. Here, the court explained, the activity that gives rise to a claim under a contract is the signing of the contract itself, therefore, liability in the Schlundt’s case arose back in 2003 when the personal guaranty was signed. The court also reasoned that this test “captures a larger number of claims (i.e., contingent and unmatured)” and, therefore, is most consistent with the definitions of “debt” and “claim.” Finally, the court noted that the language of the personal guaranty “expressly contemplated future indebtedness” by including the phrase “whether now existing or hereinafter incurred,” thereby giving rise to a contingent liability at the time the guaranty was signed.
For each of those reasons, the Schlundt court ruled in favor of the Schlundts, holding that the discharge they received in April 2014 discharged Schlundt from his 2003 personal guaranty, thereby extinguishing any personal liability for the 2018 invoices. At least one Florida bankruptcy court has come to the same conclusion on an almost identical factual scenario, and other decisions from bankruptcy courts across the state and from the U.S. Court of Appeals for the Eleventh Circuit suggest that those courts would decide similarly. Indeed, the Eleventh Circuit has adopted a hybrid conduct-relationship test in determining whether other types of claims arose pre- or post-petition.
This case, and others like it, highlight the fact that a supposed unconditional, absolute and irrevocable guaranty may not be so iron-clad or as continuing as a creditor might hope or expect. Furthermore, it stresses the need for creditors to remain up-to-date on the financial status of not only their customers, but also of guarantors, as well, and to seek the advice of bankruptcy counsel when either files for bankruptcy. Too often, creditors, whether lenders or suppliers of goods and services, forget about the guarantees that they have received, and failed to monitor the financial health or status of the guarantors. As this case presents, such inattention can lead to an unfortunate and may be disastrous financial result.