Understanding Personal Guarantees and Piercing the Corporate Veil
When a business files for bankruptcy, creditors often assume that their chances of recovery have vanished. In many cases, this is true—the corporate entity’s assets are liquidated, and debts are discharged. However, for certain creditors, opportunities may remain to collect from individuals behind the business. Specifically, creditors may pursue repayment through personal guarantees or, in rare cases, by piercing the corporate veil.
Understanding the legal mechanisms that allow creditors to go beyond the bankrupt business and hold individual owners or officers accountable is critical for maximizing recovery. In this blog, we’ll break down:
- The legal boundaries between a corporation and its owners
- How personal guarantees override those boundaries
- What it means to pierce the corporate veil
- Circumstances under which courts allow creditors to reach business owners
- How Tatman Legal can help creditors explore and pursue post-bankruptcy remedies
Corporate Entity vs. Individual Liability
In general, corporations and LLCs are treated as separate legal entities. This means that the owners, shareholders, officers, and directors of the business are shielded from personal liability for the company’s debts. The entire purpose of forming a corporation or limited liability company is to limit the personal risk associated with business failure.
However, this protection is not absolute. There are specific situations where the law allows creditors to pursue individuals for a company’s debts. Two common legal pathways for doing this are:
- Enforcing a personal guarantee
- Piercing the corporate veil
Understanding the differences between these two approaches is essential for evaluating collection options.
Personal Guarantees: A Direct Path to Collection
A personal guarantee is a contractual agreement where an individual agrees to be personally responsible for a debt if the business cannot pay. These are common in situations such as:
- Small business loans
- Commercial leases
- Vendor or supplier credit agreements
In these cases, the creditor can pursue the guarantor directly if the business defaults—even if the business has filed for bankruptcy.
Key Features of a Personal Guarantee
- Contractual Obligation: A personal guarantee is a legally binding contract.
- Survives Corporate Bankruptcy: The guarantee is separate from the corporate debt and is not discharged by the company’s bankruptcy.
- Broad Scope: Some personal guarantees are unlimited, meaning the individual is responsible for the full amount owed.
Enforcing a Personal Guarantee
To enforce a personal guarantee, the creditor must:
- Prove the existence of a valid, signed guarantee
- Demonstrate that the underlying debt is due and unpaid
If these conditions are met, a creditor can sue the guarantor in civil court and obtain a judgment. Once a judgment is secured, creditors can pursue collection through wage garnishment, bank levies, or other legal means, depending on state law.
Defenses to a Personal Guarantee
Guarantors may attempt to avoid liability by claiming:
- The guarantee was not properly executed
- They were misled or coerced
- The guarantee was limited or conditional
However, courts generally enforce personal guarantees strictly, especially if the document is clearly written and properly signed.
Piercing the Corporate Veil: A Legal Exception
Unlike a personal guarantee, piercing the corporate veil is not based on contract but on legal doctrine. It is a remedy available in cases where the corporation was used as a sham or to perpetrate fraud.
What Does It Mean to Pierce the Veil?
Piercing the corporate veil allows a creditor to hold shareholders, officers, or directors personally liable for the debts of the business. This remedy is only available in exceptional circumstances, and courts are generally reluctant to apply it.
Legal Grounds for Piercing the Veil
Each jurisdiction has its own legal standard, but common factors include:
- Commingling of personal and corporate assets
- Undercapitalization of the business at formation
- Failure to observe corporate formalities (e.g., no board meetings, no bylaws)
- Using the corporation to commit fraud or injustice
- Lack of separate identity between the business and its owners
Creditors seeking to pierce the veil must typically prove that:
- The corporation was not truly operating as a separate entity
- The owner used the corporate form to commit wrongdoing
- The result of not piercing the veil would be an injustice
Burden of Proof
The burden of proof lies with the creditor, and the standard is high. Courts will evaluate the totality of circumstances and are more likely to allow veil piercing in cases involving:
- Fraudulent transfers
- Ponzi schemes or deceptive practices
- “Alter ego” scenarios where owners treat corporate accounts as personal bank accounts
Veil Piercing in LLCs
Limited liability companies (LLCs) are subject to veil piercing under similar doctrines. While LLCs are often more informal than corporations, courts may still impose personal liability when the entity is abused.
Corporate Bankruptcy and the Creditor’s Strategy
When a business files for Chapter 7 or Chapter 11 bankruptcy, the court typically issues an automatic stay preventing creditors from collecting against the business. However, this stay does not apply to personal guarantors unless they also file for bankruptcy.
Evaluating the Creditor’s Options
When faced with a corporate bankruptcy, creditors should:
- Review loan documents, leases, and agreements for personal guarantees
- Identify any individual owners or officers who may be liable
- Investigate corporate records for signs of misconduct or fraud
- Consider whether veil piercing may be an appropriate remedy
In some cases, it may be advisable to:
- File a lawsuit against the guarantor while the bankruptcy proceeds
- Intervene in the bankruptcy to protect your claim
- Conduct discovery to uncover misuse of corporate form
Real-World Examples
Example 1: Personal Guarantee Enforcement
A supplier provided $100,000 worth of equipment to a startup business. The business defaulted on payments and filed for Chapter 7 bankruptcy. However, the CEO had signed a personal guarantee when establishing the credit line. The creditor was able to sue the CEO directly, win a judgment, and recover a portion of the debt through wage garnishment.
Example 2: Veil Piercing in Fraudulent Conduct
An investor loaned $250,000 to a real estate development company, which was operated entirely by one individual. The company had no separate bank account, no formal operating agreement, and no corporate records. Funds were diverted to pay the owner’s personal mortgage. The court found that the company was the owner’s alter ego and allowed the creditor to collect directly from the individual.
The Importance of Early Legal Action
Timing is critical. If a creditor waits too long, they may lose the opportunity to:
- Object to a discharge
- File an adversary proceeding
- Secure a judgment against a personal guarantor
Engaging legal counsel early in the bankruptcy process enables creditors to preserve their rights and take proactive steps. Tatman Legal routinely represents creditors navigating complex business bankruptcies, and we have the tools and experience to:
- Review contracts for enforceable guarantees
- Investigate corporate misconduct
- Litigate veil piercing claims
- Defend creditor interests during bankruptcy proceedings
How Tatman Legal Can Help
When a business goes bankrupt, all is not necessarily lost for creditors. If you are owed money by a company that has filed for bankruptcy, Tatman Legal can help you determine whether you have recourse against the business owners or guarantors. We have extensive experience with creditor representation, bankruptcy litigation, and post-bankruptcy recovery strategies.
Our team can:
- Analyze your case for potential personal liability
- Help enforce personal guarantees
- Build a case for veil piercing where appropriate
- Represent your interests in bankruptcy court
Don’t leave money on the table. Contact Tatman Legal today to schedule a consultation and explore your options for recovery—even after a business has filed for bankruptcy.