Discharge (bankruptcy)

Definition

The court order ending your personal liability for a debt; liens survive it.

Why It Matters

For a guarantor it reaches the guaranty itself. The Bankruptcy Code lists the debts a Chapter 7 discharge does not touch, and a guaranteed business loan is not on it. The list names taxes, fraud, support and educational loans, so a lender keeps the debt alive only by asking the court. It can ask to except this one debt, for fraud in getting the loan or for willful and malicious injury to its collateral, or object to the whole discharge, for hiding assets among other grounds. Three things it does not do. It does not free the business, since only an individual gets one. It does not remove a lien, so a house pledged as collateral stays exposed to the balance the lien secures, and the lender can ask the court for leave to go after collateral while the stay holds. The SBA's own servicing rules tell a lender to try to release a residence lien for consideration before foreclosing on a primary home. And it does not stop the tax form, since a balance discharged is reported as canceled debt the following year, though the tax code keeps a debt discharged in a bankruptcy case out of income. After a discharge the SBA treats the loan as legally uncollectible from that guarantor and charges it off; that guarantor is not referred to Treasury. Treasury's offset program takes only debts that are legally enforceable and not in bankruptcy. A guarantor who wants to keep paying can reaffirm the loan in an agreement made before the discharge and filed with the court, which must approve it when no lawyer negotiated it. That is the one way the personal liability survives by choice.

In numbers: A guarantor with a $400,000 deficiency who is discharged in Chapter 7 owes nothing further on the note. The lender's lien on the pledged house survives, so the house is still at risk for the balance the lien secures, and the SBA charges off the loan instead of sending that guarantor to Treasury offset.