Lenders Beware: The Effect Of Bankruptcy On Personal Guaranties

• Published date: 17 September 2021
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Insolvency/Bankruptcy
• Law Firm: Reinhart Boerner Van Deuren s.c.
• Author: Mr Frank W. DiCastri

A well-drafted personal guaranty of payment and performance provides peace of mind for the diligent lender. It is not only irrevocable, but also covers future extensions of credit and includes broad waivers of defenses. Even when a lender is faced with a bankruptcy proceeding, the guarantor's promise to pay the full amount of a debt is inviolate: a claim against the guarantor need not be reduced to account for recoveries from other sources unless and until the creditor is paid in full. As long as the creditor does not collect more than it is owed, it may prosecute its bankruptcy claim for the full amount of a guaranty obligation, regardless of the current balance on the debt. See, e.g., Reconstruction Finance Corp. v. Denver & R.G.W.R. Co., 328 U.S. 495, 529 (1946) ('The rule is settled in bankruptcy proceedings that a creditor secured by the property of others need not deduct the value of that collateral or its proceeds in proving his debt.') (citing Ivanhoe Bldg. & Loan Assoc. v. Orr, 295 U.S. 243 (1935)).

In general, a claim against a personal guarantor is just that: a cause of action against one who promised to pay; an unsecured claim. And like most unsecured debts, a guaranty obligation can be discharged in a bankruptcy proceeding. But what about new extensions of credit'advances made to the primary obligor after the guarantor's discharge in bankruptcy? The answer resides in a recent decision from Judge Beth E. Hanan, in the U.S. Bankruptcy Court for the Eastern District of Wisconsin, confirming what lenders may have feared all along'those debts, too, are discharged.

In Reinhart Food Service L.L.C. v. Schlundt (In re Schlundt), Adv. No. 20-2091-beh (Bankr. E.D. Wis. August 19, 2021), Judge Hanan used the 'conduct test' to determine whether the personal guaranty signed by Mr. Schlundt in 2003 created a pre-petition debt that was discharged in the Schlundts' 2014 chapter 7 bankruptcy, or 'set the stage' for a post-bankruptcy debt incurred when Reinhart Food Service extended credit in 2018. Under the conduct test, 'the date of a claim is determined by the date of the conduct giving rise to the claim.' Id. (citing Saint Catherine Hosp. of Ind., LLC v. Ind. Family and Soc. Servs. Admin., 800 F.3d 312, 315 (7th Cir. 2015)). The test can be contrasted with the 'accrual theory,' by which the date of a claim was determined with reference to state law that dictates when liability for the claim arose.

The conduct giving rise to a contract claim is usually the...