By Gary Wartik
April 2, 2014

It is a familiar scenario. A business is closing, but there is still a significant balance due on the real property lease. In almost all cases that this office has observed, the principals of the business have been required to sign personal guarantees of their company’s real property lease(s), even when the company is incorporated. In a majority of cases, equipment leases are also backed by personal guarantees. In some cases, principals have been required to offer collateral to secure the personal guarantee, although in the majority of property leases, the guarantee is not collateralized.

Under California law, and in bankruptcy proceedings, there is a statutory order of priorities that are payable when a business closes and its assets are liquidated. Claims that are secured by specific assets of a company are usually paid in full, to the extent the asset pledged is sufficient to pay the claim. Among the highest priorities after consideration of secured claims are those for a specified amount of unpaid wages, certain contributions to employee benefit plans, customer deposits and most taxes.

The landlord’s claim, even supported by a personal guarantee, does not enjoy priority status. So, we then have a situation in which the principals have lost their business, and the investments represented thereby, and yet they face the task of dealing with a landlord who is looking to collect on a personal guarantee. While a sale of the company’s assets may yield a reasonable amount of cash, in the usual situation there won’t be enough to pay more than a fraction of the company’s debts.

This office has dealt with numerous situations of this type over the years. The landlord can always have what is known as an “unsecured claim” against proceeds of the liquidation, but that means standing in line with the other unsecured creditors to obtain a pro-rata share of the liquidated proceeds. What often occurs, however is that the principals are pressured to reach a settlement with the landlord, either through use of personal funds or by reassigning some of the liquidation funds available for all creditors in exchange for release of the personal guarantee. This tends to serve to decrease the amount of funds available for distribution to other creditors.

Principals often do not have personal funds available to satisfy even a small portion of the personal guarantee they gave the landlord. When that situation arises, some principals have been driven to file personal bankruptcy to avoid the personal guarantee. The more preferred approach is a negotiated settlement of the landlord’s claim and the personal guarantees.

Typical of this situation, during 2013 Vision Economics had a client with more than $250,000 due on the lease at the time the business closed. This presented enormous pressure on the two principals involved because they did not have the funds, nor the mindset to apply their remaining limited personal assets to resolve the guarantee. This office then negotiated a settlement that took more than four months to achieve, but resulted in the principals using none of their personal funds to meet the guarantee. While we won’t offer details here as to exactly how that settlement and release were reached, persuasion, use of the threat of personal bankruptcy filings and use of some of the closed company’s assets all played a role in reaching a reasonable settlement under the challenging circumstances that were in place.

If you or a client have an unresolved situation related to a real property or equipment lease with personal guarantees, please give us a call at 805-987-7322.

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