A ruling by federal bankruptcy judge in North Carolina makes it more difficult for banks to force debtors to sign a new personal guaranty after discharge in bankruptcy. The decision could have wide ranging implications and help borrowers.
In re Schwarz
Dr. Karl Schwarz is a physician in Raleigh? North Carolina. Over the years, his plastic surgery practice borrowed money for equipment. Typical in many small business transactions, Dr. Schwarz signed personal guaranties as part of the financing packages. In 2009, he filed bankruptcy.
Even though Dr. Schwarz and his wife filed for bankruptcy, he continued to practice medicine and remained current on the equipment loans. In 2010, he and his wife were granted discharges of all their personal debt. Included in their schedule of debt was the personal guaranty signed by Dr. Schwarz.
Dr. Schwarz’s financial woes persisted and in late 2012 the practice defaulted on the equipment loans. Trying to keep his doors open, Dr. Schwarz began discussing a workout plan. His lender offered a forbearance agreement that included lower monthly payments and longer payout term. The lender also demanded – and received – new personal guaranties. This time his wife was also asked to guaranty the loans.
When the practice then defaulted on the forbearance agreement, the lender elected to try and collect from Dr. Schwarz and his wife. The Schwarz’ claimed that the guaranty was unenforceable and sought damages from the lender.
Bankruptcy Discharge Injunction
Under the federal Bankruptcy Code, a discharge extinguishes all debt of the debtor*
. Once the debtor receives a discharge, creditors cannot commence an action to recover the old debt. The injunction also prevents creditors from offsetting the old debt or inducing the debtor to repay the old debt.
The rational is quite simple and consistent with the Bankruptcy Code. Congress wants debtors to have a fresh start. Allowing creditors to collect post discharge would render the bankruptcy process meaningless.
There is an exception for post discharge repayment agreements that are made before the discharge. Those agreements must be filed with the court. Sometimes they also must be approved by the court.
Things get murky when a lender later asks a borrower to sign a new personal guaranty post discharge. Those guaranties are sometimes enforceable if a new loan is made. That wasn’t the case here, however.
An exception may also available if the bank provides new and independent consideration. The most common example is additional credit or money offered to the borrower. If Dr. Schwarz owed $500,000 before the bankruptcy and several years later that bank agreed to loan him an additional $250,000, one could successfully claim that the new money is new consideration. In that case, the bank would be justified in asking for a new personal guaranty
Are more favorable payment terms “new and independent” consideration? No said the court.
Court Voids Personal Guaranty Against Dr. Schwarz
While the court found there was consideration in the form of lower payments and an extended payout period, the consideration was based on the old discharged obligation. In the words of the court, “Instead, the court finds that unless the Forbearance Agreement is not in any way supported by a promise by Debtor to pay the obligation due under the original agreements, it cannot be found valid and enforceable. Accordingly, if the consideration for the Forbearance Agreement was based in whole or in part by debt that was discharged, it will not be found valid.
The ruling was handed down on February 3rd. The court withheld determining whether the lender, Americorp, should be sanctioned. Under section 105 of the Bankruptcy Code, a violation of the discharge injunction is punishable by civil penalties if the violation was willful. The determination of sanctions will be decided at a future date.
The scope of the court’s opinion is quite broad and should serve as the basis to invalidate many post bankruptcy guaranties made as part of a modification or guaranty.
Court Upholds Personal Guaranty of Shauna Schwarz
Dr. Schwarz’ wife was not so lucky. Because she was never a guarantor at the time of the original bankruptcy filing, there was no violation of the bankruptcy discharge injunction. Her guaranty is therefore enforceable.
Lenders that Require Post Discharge Personal Guaranties on Thin Ice
Lenders that modify your loan or have you sign a forbearance agreement after discharge, may be violating the bankruptcy discharge injunction if they require you to sign a personal guaranty. Not only may that guaranty be void, the lender could even be liable for damages.
Borrowers emerging from bankruptcy are particularly vulnerable to overreaching behavior by banks. We see many bankruptcies where borrowers go file for personal bankruptcy even though their businesses continue to operate and make payments to creditors.
Some lenders think they can use their leverage to reinstitute a personal guaranty after bankruptcy. Most lenders know they violate the bankruptcy discharge injunction by simply demanding they sign a new guaranty. Instead, they will attempt to legitimize their behavior by making it appear that the guaranties are part of a forbearance agreement or modification.
Interested in whether you have a case against your bank? Are you asking yourself, “Can I sue my bank”? Give us a call. We are two boutique lender liability law firms that join forces to sue banks. Our practices are national but we offer Midwest quality service and prices.
For more information, contact attorney Chris Katers at [hidden email] or by telephone at (414) 777-0778. The author of this post, attorney Brian Mahany, can be reached at [hidden email].
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*section 524 contains the bankruptcy injunction language. It says:
11 U.S.C. §524(c) provides that “An agreement between a holder of a claim and the debtor, the consideration for which, in whole or in part, is based on a debt that is dischargeable in a case under this title is enforceable only to any extent enforceable under applicable nonbankruptcy law; whether or not discharge of such debt is waived, only if – [the reaffirmation provisions set out in subparagraphs 1 – 6 are complied with]”.
Those provisions require the reaffirmation be voluntary. Courts rarely find they are voluntary.