Bankruptcy Restructuring & Guarantee Liability
Many lenders and lessors require that the borrower (or lessee) provide someone to guarantee the obligations through one or more guaranties. The theory of this requirement is that an individual or entity with substantial net worth or assets beyond the business-entity debtor will make sure that there is performance on the underlying obligation. However, what if the project needs more time to perform or a default occurs? Hopefully, both parties can mutually agree to a payment timetable. But if an agreement cannot be reached, a bankruptcy action filed by the underlying entity may allow for relief to the Guarantor even without the Guarantor filing for its own bankruptcy protection (and even where a bankruptcy for the Guarantor is not appropriate).
In some cases, it is possible to get a Guarantor some relief in a court-ordered restructuring of the underlying debt. This is a developing area of the law in bankruptcy courts. However, injunctions to prevent immediate action or to stay actions against the Guarantors can be available as soon as the underlying entity files for bankruptcy. This will either prevent a lawsuit from being filed against the Guarantor or if a lawsuit is already filed stop that lawsuit from proceeding further during the bankruptcy.
In a bankruptcy case, it may be appropriate for the court to adjust the debtor’s repayment term or stretch term and adjust the amount of interest/reduce the interest rate to a market rate as part of confirmation process/debt restructuring. It may also be possible to have the injunction preventing actions against the Guarantors last during the entire time of the restructured plan, provided the following conditions are met:
- The Guarantors make a significant contribution and are necessary to the proposed reorganization;
- The Debtor performs under the terms of the plan of reorganization;
- The Plan pays the debt in full with an appropriate interest rate;
- There are “unusual circumstances” – such as where a suit against the Guarantor for all practical purposes would be a suit against the Debtor or the Guarantor action would have an adverse impact against the reorganization.
There may be additional safeguards the court believes are appropriate before granting an injunction.
In Arizona, these post-confirmation injunctions have been issued in numerous cases. Our firm was involved in a case where the court did not confirm a plan because of the requested post-confirmation injunction, but did continue to stay the action while the matter was raised on appeal – this meant no action was taken against the Guarantors from the time the case was filed until the appeal was heard – a three year period.
During this time payments to the secured creditor were limited to interest only on the underlying value of its collateral. In another case, the court did confirm a post-confirmation injunction that lasted 10 years at a market rate of interest.
These two cases were decided by two different bankruptcy judges who recently retired. The bankruptcy judges who replaced them have not yet addressed stays against Guarantor actions but are likely to be sympathetic to be granting these injunctions. One of the judges argued the appeal from the denied confirmation specifically advocating for the permissibility of these injunctions. Whether you are a debtor or a creditor in these situations you need to be aware of these types of injunctions in evaluating the risk/reward of working out a potential solution to a troubled loan.