The banks invariably require the owner of small businesses to sign a personal guarantee to secure a loan. But what happens to the personal guarantee when the owner dies and the business defaults on the loan?
If the business defaults on the loan, the decedent’s estate can be on the hook to repay the loan. This is an issue that comes up in the probate administration process. This can allow the lender to go after more than just the collateral securing the loan. The lender can, in theory, collect from any and all of the decedent’s assets.
There are rules that apply here, naturally. The Whitener v. Origins Bank, No. 14-22-00235-CV (Tex. App.–Houston [14th Dist.] 2023) case provides an opportunity to consider these rules. The case also shows why personal guarantees have to be factored into one’s estate plan.
Facts & Procedural History
This case involves a husband and wife. The husband was survived by his wife.
In 2014, the husband signed a guarantee for a loan on a corporation that he owned. The guarantee was for a loan the bank made to the corporation. The loan was secured by a lien and security interest against accounts, stock, and equipment owned by the corporation.
The husband died in 2020. The trustee of the trusts created in the decedent’s will signed guarantees for the loan the corporation owed to the bank.
The corporation defaulted on the loan in 2021 and filed for bankruptcy.
The bank filed an unsecured claim to collect from the husband’s probate estate based on the guarantee. The claim was rejected by the executor. The bank filed suit in district court to collect on the claim. The district court granted summary judgment in favor of the bank for breach of the guarantee.
The estate filed an appeal based on several arguments. One was that the bank was a secured creditor and failed to make a timely election, therefore, the bank’s recovery was limited to the collateral it already recovered from the corporation.
Secured vs. Unsecured Creditors
Secured creditors have a legal claim to specific assets or collateral that the debtor has pledged as security for a loan or debt. The collateral could be real estate, vehicles, inventory, or any other valuable asset.
The creditor has a security interest or lien on the collateral, which gives them the right to seize and sell the assets to recover their outstanding debt if the debtor fails to fulfill their repayment obligations. In the event of default or bankruptcy, secured creditors have priority over unsecured creditors in accessing the proceeds from the sale of the collateral to recover the debt owed to them.
If the proceeds from the sale are insufficient to cover the full debt, the secured creditor may have the right to claim the remaining amount from other assets of the debtor. Examples of secured creditors include mortgage lenders and auto loan providers.
Unsecured creditors, on the other hand, do not hold any specific collateral or security interest against the debtor’s assets. They have extended credit or provided goods or services to the debtor based solely on the belief in the debtor’s ability to repay the debt. In case of default or bankruptcy, unsecured creditors do not have a specific claim on any particular asset of the debtor. They are typically paid out of the remaining assets of the debtor after the secured creditors have been satisfied. However, the amount that unsecured creditors receive may be significantly lower as they are further down the priority ladder. Examples of unsecured creditors include credit card companies, suppliers, and vendors.
Secured Creditors in Texas Probate Cases
The Texas Estates Code provides special rules that apply to secured creditors who are seeking to recover money. Secured creditors either have a (1) matured secured claim or (2) preferred debt and lien.
The lender with a “preferred debt and lien” is only entitled to collect against the collateral securing the loan. This can be helpful if the collateral went up in value. It is not helpful if the collateral went down in value.
The alternative is the “matured secured claim” in which the lender is treated as any other creditor and the probate rules that provide for who gets paid dictate what the lender is to be paid. As explained below, the probate rules set out eight classes of claims and they are paid in order, class 1 first and then ending with class 8, until the money or assets of the estate are depleted or all claims are paid.
The default classification is “preferred debt and lien.” To elect the “matured secured claim” classification, the secured creditor must notify the administrator within six months of the issuance of letters or four months after receiving written notice from the executor.
It is crucial to adhere to these timeframes. Additionally, if the collateral is real estate, the creditor must file a claim and record a notice of the “matured secured” election in the deed records of the county where the land is located.
If a secured creditor fails to notify the administrator within the required timeframe or does not complete the necessary filings and recordings, the claim will default to the “preferred debt and lien” classification.
Claims for Money Under the Texas Probate Rules
When it comes to settling the affairs of an estate in Texas, claims for money against the estate need to be classified and prioritized for payment. The Texas Estates Code provides guidelines for the classification and priority of payment of these claims and their corresponding priority levels.
Class 1 Claims: Funeral and Last Illness Expenses
Class 1 claims consist of funeral expenses and expenses related to the decedent’s last illness. These expenses, up to a reasonable amount approved by the court, include reimbursement claims. The maximum allowable amount is set at $15,000 for funeral expenses and $15,000 for expenses related to the decedent’s last illness. Any excess beyond these limits is reclassified and treated as other unsecured claims.
Class 2 Claims: Administration Expenses
Class 2 claims encompass various expenses related to the administration of the estate. This includes the costs incurred in preserving, safekeeping, and managing the estate. It also covers fees and expenses awarded under Section 352.052. Additionally, any unpaid expenses of administration awarded in a guardianship of the decedent and court costs and commissions for estates where a public probate administrator has taken action under Chapter 455 fall under Class 2 claims.
Class 3 Claims: Secured Claims
Class 3 claims consist of secured claims for money that are matured secured claims. This includes claims with a mortgage or lien on the specific property. The payment of these claims is made from the proceeds of the property subject to the mortgage or lien. If multiple mortgages, liens, or security interests exist on the same property, the claims are paid in order of priority of the mortgage, lien, or security interest securing the debt.
Class 4 Claims: Delinquent Child Support
Class 4 claims pertain to delinquent child support payments. This includes claims for the principal amount and accrued interest on child support arrearages confirmed by a court or administratively determined by the Title IV-D agency. Unpaid child support obligations under Section 154.015 of the Family Code also fall under this class.
Class 5 Claims: Taxes and Penalties
Class 5 claims cover taxes, penalties, and interest due under various codes, including the Tax Code, Occupations Code, Natural Resources Code, Municipal Sales and Use Tax Act, Transportation Code, and Chapter 452 of the Transportation Code.
Class 6 Claims: Cost of Confinement
Class 6 claims consist of claims for the cost of confinement established by the Texas Department of Criminal Justice under Section 501.017 of the Government Code.
Class 7 Claims: Repayment of Medical Assistance Payments
Class 7 claims encompass claims for repayment of medical assistance payments made by the state under Chapter 32 of the Human Resources Code, provided to or for the benefit of the decedent.
Class 8 Claims: Other Claims
Class 8 claims include any claims that are not described in the categories above. These claims fall into a residual category and cover a range of miscellaneous claims not specifically classified elsewhere. This includes most unsecured creditors, for example.
The Decedent’s Personal Guarantee is Unsecured
That brings us back to this case. In this case, the bank was a secured creditor of the corporation. The shares of the corporation were an asset held by the estate or trusts.
The bank was an unsecured creditor of the estate as the decedent merely signed a guarantee for the loan. The decedent did not pledge any of his assets for the loan. He merely agreed to be liable in the event that the corporation did not pay the loan.
The court rejected the personal representative’s argument that the bank was a secured creditor. The implication is that the “preferred debt and lien” rules for secured creditors of the estate did not apply. Had these rules applied, the bank could only look to their collateral and, apparently, they had already received their collateral. Thus, the bank would not have been able to recover (and, presumably, it could not recover from the corporation, as the corporation filed for bankruptcy).
Planning for Personal Guarantees
If the value of the property is likely to decline in value, one might prefer that the secured creditor rules apply. This can often be accomplished by having the business owner take out the loan directly. They could then contribute the funds to the corporation as a capital contribution or a back-to-back loan. The bank would then be a secured creditor of the estate. The loan would default to a preferred debt and lien if the bank did not timely file a notice to the contrary.
The decedent may also be able to simply transfer assets out of the business during their lifetime or prioritize payment of loans that are personally guaranteed. A life insurance policy may also be purchased to pay the loan. These are just a few of the estate planning considerations for a business owner who has signed personal guarantees for loans.
It is common for business owners to sign personal guarantees. They do so with the aim of growing their businesses or assets during their lifetimes. As this case shows, when the business owner dies and their business fails, the personal guarantee does not convert to a secured loan for the estate. It remains an unsecured liability for the estate. This means that the estate and personal representative have to pay other parties first, according to the eight classes set out in the Texas Estates Code.
Our Houston Probate Attorneys provide a full range of probate services to our clients, including helping with claims for money filed in probate cases. Affordable rates, fixed fees, and payment plans are available. We provide step-by-step instructions, guidance, checklists, and more for completing the probate process. We have years of combined experience we can use to support and guide you with probate and estate matters. Don’t let family disputes complicate your probate case. Get your free consultation today and let us guide you through the process.
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