Using Temporary Restraining Orders to Protect Personal Guarantors of a Business

Courthouse facadeHere is a common scenario. The founders of a company get a loan for their business and give a lien to the lender on the piece of property owned by the company. The lender requires a personal guarantee from the business owners. Something bad happens with the business, and the corporation falls behind on the loan. Lender accelerates the loan, demanding full payment. Once that payment invariably is not paid, lender sues both the corporation and the personal guarantors of the business.

The business experience some hiccups, and now wants to reorganize under Chapter 11. The automatic stay stops the lawsuit as to the corporation, but what about the owners with their personal guarantees?

Since they did not file bankruptcy, and presumably do not want to or maybe cannot for a variety of reasons, the owners are now trying to simultaneously reorganize their business and defend a lawsuit. That is a full plate. A preliminary injunction, or temporary restraining order (“TRO”), by the corporation in bankruptcy against the lender continuing the state court action against the personal guarantors may be the solution to protect the owners.

A TRO in this case is a bankruptcy court ordering the plaintiffs in the state court lawsuit to cease further litigation for a limited period of time. A bankruptcy court may choose to do this if the state lawsuit threatens to interfere with property of the bankruptcy estate or the ability of the entity that filed bankruptcy from successfully reorganizing.

By continuing a lawsuit against the owners in state court, think of what it does to the reorganization efforts of the business. Can the lender foreclose on the property? If so, the lender is essentially using another court to take property from the bankruptcy estate, which means other creditors may not see a return or as high of a return on their debts. The lender could get a duplicative recovery. If it recovers $.50 on the dollar in bankruptcy, and $.75 on the dollar in state court, the lender has gone beyond making itself whole.

Also, bankruptcy courts are sensitive to the distraction and costs associated with litigation in other forums. Forcing the owners to defend a state court lawsuit jeopardizes their ability to operate the company, and reorganize in Chapter 11.

In order to obtain a preliminary injunction, the owners would need to show: (1) a strong likelihood of success on the merits, (2) the likelihood of irreparable injury to plaintiff if preliminary relief is not granted, (3) a balance of the hardships favoring the plaintiff, and (4) that an injunction advances the public interest.

Without more facts, completing an analysis of this standard is not really helpful in this post. But, you can tell from the time sensitive nature of a TRO, there needs to be a realistic plan of reorganization in the pipeline fairly quickly. A bankruptcy court is not interested in interfering with a state court proceeding or with creditors when there is no plausible plan for reorganization. But this could be a useful tool for protecting owners and buying a little time to reorganize a business.