At the peak of the coronavirus pandemic, one of the generous stimulus programs that Congress created to help struggling businesses stay open was the Covid-19 Economic Injury Disaster Loan (EIDL) program through the Small Business Administration (SBA). Over the life span of the EIDL program, the lending initiative provided more than $390 billion in assistance to various businesses and helped to lessen one of the worst economic crises since the Great Depression. The loans were made directly by the SBA, and provided low-interest, fixed-rate long-term financing at 3.75% for businesses and 2.75% for nonprofit organizations.
The purpose of SBA EIDL loans was to provide funding to help small businesses recover from the economic impacts of the COVID-19 pandemic. This included not just incorporated businesses but also unincorporated, sole proprietorships and the self-employed. As a result, this loan program was available not just to the owner of the small restaurant whose business dropped because people remained home during COVID, but also to the Uber driver who suffered financial losses during the pandemic as well. The funds were intended to be used for working capital for businesses to make regular payments for operating expenses, including payroll, rent or mortgage, utilities, and any additional ordinary business expenses. Since the loan terms allowed it to be put towards payroll, many borrowers used the funds as replacement for their lost income.
Many small business owners affected by the COVID-19 pandemic took part in the EIDL program from the SBA to help keep their businesses afloat. A wide variety of businesses took part in the program. From Uber drivers, restaurants of all sorts, trucking companies, auto shops, barbershops, and even dentists, many businesses that saw a significant decrease in revenue took part. These funds from the SBA were a lifeline for many Americans and business owners at the height of the Pandemic.
In January 2022, the SBA stopped accepting applications for new EIDL loans after a couple rounds of funding. The loan terms were for 30 years at an interest rate of 3.75% and the first two years of payments were deferred. It was a great offer, and many businesses took advantage of the program. Unfortunately, it also attracted a significant amount of fraud. For example, the Justice Department is prosecuting three individuals for fraudulently obtaining approximately $5 million of federal Paycheck Protection Program (PPP) loans and EIDL loans and for laundering the loan proceeds. They prepared fraudulent PPP and EIDL applications for businesses with little or no operations who then shared the proceeds with the perpetrators of the scheme. While that is a blatant example of fraud, other borrowers may have improperly used the loan proceeds as authorized, but on a much lesser scale.
As of May 6, 2022, the SBA ceased the processing of EIDL loan increase requests or requests for reconsideration due to a previously declined loan application. Initially, the SBA decided not to pursue collection of defaulted EIDL loans, but in December 2023, the Biden administration reversed this policy and sought to collect an estimated $30 billion in delinquent debt. The SBA, through the Treasury Department, now plans to more aggressively pursue thousands of small businesses and self-employed individuals that have past-due loans. The default rate for SBA EIDL loans is very high and is now estimated at 37%.
The amount of the SBA loan a business obtained through the program affects the actions that the Treasury Department can take when collecting:
Borrowed up to $25,000 in SBA loan.
SBA loans up to $25,000 were unsecured, so the SBA did not require any collateral to obtain these loans. This means that the SBA is not able to go after the business’ assets to collect the loan. Additionally, these loans did not require a personal guarantee from incorporated businesses. A personal guarantee would allow the SBA to collect directly from the business owner. However, unincorporated businesses, sole proprietorships and the self-employed obtained their loans in their individual capacity. Accordingly, these borrowers may be pursued directly upon default for any balance.
Borrowed more than $25,000 but less than $200,000 in EIDL loan.
For loans in excess of $25,00 but less than $200,000, the consequences for business owners are slightly more severe. Again, since the owner of an unincorporated business or sole proprietorships obtained the loan directly in an individual capacity instead of through an incorporated business, they may be sued by the Treasury Department and collected from directly. Additionally, these loans are secured by a businesses’ assets as collateral. This might not affect some small businesses and gig workers such as Uber drivers but could affect businesses that have assets with value. In pursuit of a defaulted loan, the Treasury department could seek to collect the debt and liquidate any assets in an attempt to recoup the loan balance. If there is still a further remaining loan balance, the business owner could then be sued for the deficiency.
Borrowed more than $200,000 in EIDL loan.
SBA loans for $200,000 and above required that business owners sign personal guarantees for the debt. If such an SBA loan goes into default, any guarantor will be personally liable for the balance. Even if the business shuts down, the guarantor will still owe any loan remaining loan balance. Additionally, these SBA loans placed a lien against the business’ assets and accounts receivable as collateral, but for many small businesses, their assets might not have significant value. Realistically, if a business is struggling, they may not have any sizable account receivables, and they may already have other liens asserted against their business. If a business does have assets with value or meaningful account receivables, then it can be a substantial issue for the business if they default on the loan.
Is your EIDL loan in Default?
If a borrower fails to make payments for at least three months and does not contact the SBA, then the SBA may characterize the loan as being in default. There are other circumstances that can trigger an SBA loan default as well that include:
- Violating any terms and conditions of the loan agreement, such as using funds for purposes other than those allowed for business-related expenses.
- Failing to pay any taxes when due.
- Change of ownership without SBA consent.
- Filing for bankruptcy.
What are the consequences of an SBA loan being in default?
There are a number of significant negative consequences to defaulting on an SBA loan:
- Any parties that guaranteed the loan can be sued to repay the loan balance. This could negatively affect any business owner who obtained an SBA loan for $200,000 or more and any business owner who applied individually for an SBA loan as well (those with unincorporated businesses and sole proprietorships) regardless of the amount that was borrowed.
- The Treasury Department can withhold federal payments and benefits to recoup the debt. The loan default can be reported to the IRS and the borrower may have any tax refunds withheld. The Treasury Department can garnish a debtor’s wages or a percentage of social security benefits to satisfy the EIDL loan debt. Please note, the Treasury Department does not need to obtain a court order to garnish wages or levy other benefits.
- The U.S. Treasury Department can disqualify a borrower from enrolling in other federal programs in the future.
- Any collateral (either business or personal property) pledged for the loan can be at risk.
- Business and personal credit reports may show the default and those credit scores can be negatively impacted.
What are a borrower’s options if an SBA loan is in default?
There are three main options for a borrower with an SBA loan in default. First, they can enroll in a hardship program. Second, they can submit an offer in compromise to settle the debt, and third, they can file for bankruptcy.
Hardship Programs
SBA is offering a hardship program called the Hardship Accommodation Plan (HAP) for SBA borrowers who are experiencing financial challenges. All loans that are in repayment, including past due loans, are eligible for HAP, unless the loan has been sent to the Treasury Department for collection. This generally occurs after a borrower is 180 days past due on a loan. If a loan is for less than $200,000.00, a borrower can enroll via the SBA loan portal, but if a loan is for $200,000.00 or more, entry into the program is more difficult. The borrower must speak with a loan specialist regarding the requirements.
Borrowers who are eligible for HAP may pay 10% of their usual payments for six months, without first catching up on any missed payments. The option to renew the plan is available if the hardship continues. However, interest will continue to accrue on the loan, which may increase the balance the borrower owes on the loan. The program is intended for borrowers with short term financial hardships, not those who will be unable to pay over the long term.
Submitting an Offer in Compromise
An offer in compromise is an offer submitted to the SBA that requests to settle the loan balance for a specific amount, less than the total amount owed on the EIDL loan, typically much less. In order to be eligible to receive an offer in compromise settlement, there are a number of onerous requirements:
- A borrower can only submit an offer in compromise after the liquidation of their collateral assets.
- A borrower must be able to prove their financial hardship.
- Makes the borrower ineligible for further federal programs.
- The borrower or their business cannot be involved in bankruptcy proceedings.
In addition to satisfying these requirements that may be difficult to meet, the borrower must have the funds available to pay any settlement offer received by the SBA in a lump sum. Then if their settlement offer is accepted, the SBA debt forgiven may be considered taxable income. The business owner may receive a 1099-C for the balance of the loan that was forgiven.
Filing for bankruptcy to discharge an SBA loan.
If a business or borrower with SBA debt is struggling financially, bankruptcy can be an effective way to discharge the debt from an SBA loan or series of loans. Chapter 7 bankruptcy can enable a debtor to quickly eliminate their debt and get a fresh start while chapter 13 and chapter 11 bankruptcy provides can provide a debtor with the ability to resolve all their debt through a court ordered re-payment plan. Regardless of the type of bankruptcy, once a petition is filed, a debtor receives the benefits of the Automatic Stay, which typically prohibits all debt collection activity.
Unfortunately, a debtor must include all their debits in a bankruptcy filing and cannot file just for their SBA loans. Depending on the particular situation, a debtor may choose different chapters of bankruptcy. First, it must be determined who is filing. Is the owner filing or the business? If the business owner is filing and the business is already closed or keeping it open is not financially realistic, Chapter 7 bankruptcy may be the best option. This will allow a business owner to eliminate their business debt, including personally guaranteed or owed SBA loans and obtain a fresh financial start. In a Chapter 7 bankruptcy case, a debtor can protect their exempt assets using the applicable bankruptcy exemptions. For debtor’s filing for bankruptcy in New York, typically they can protect their household goods and electronics, a motor vehicle, a certain amount of equity in their home, 401k, 403b, IRA and pension accounts, life insurance, worker’s compensation awards, certain value in a personal injury case, and in some circumstances, even money in the bank. However, if they have non-exempt assets that are not covered by the allowable bankruptcy exemptions or earn too much income to file for chapter 7 bankruptcy they may choose to file a Chapter 13 bankruptcy instead.
If a debtor files for Chapter 13 bankruptcy, they can restructure their debt into an affordable payment plan that is approved by the Bankruptcy Court and all creditors are bound by it. In the plan, the debtor pays the claims of their creditors, in most cases, interest free. Depending upon the type of claims, debtor’s assets, and budget, they may only pay a percentage of the debt owed. However, if they are above the debt limits for a Chapter 13 ($465,275 for unsecured debt and $1,395,875 for secured debt), they would be restricted to filing for Chapter 11 bankruptcy or Subchapter V.
If a business is seeking to remain open and can financially afford to do so, Chapter 11 or Subchapter V may be the best option. Subchapter V is for small businesses and business owners who are engaged in commercial or business activities (other than primarily owning or operating a single piece of real property) with total secured and unsecured debts of $3,024,725 or less. Additionally, a majority of the debt must be connected to the commercial or business activities of the debtor. Chapter 11 is for businesses seeking to reorganize and continue operation or for individuals who do not qualify for Chapter 13 or Subchapter V.
In a Chapter 11 or Subchapter V case, the debtor reorganizes their business with a plan that creditors accept through a voting process, and the Court then confirms it. If the business is not financially viable and has assets that may be liquidated to pay off the business’ debts, then the business may file for Chapter 7 bankruptcy. If the business has little to no assets, they may just want to close the business and pursue an individual bankruptcy filing on the debt owed by a business owner either personally guaranteed or individually.
No matter which chapter of bankruptcy a debtor files for, at the end of their case, they are provided with a discharge of their debt and receive a fresh financial start. Furthermore, any debt cancelled by the bankruptcy does not create any tax liability, in contrast to receiving an offer and compromise that may result in such a liability.
Business owners can receive debt relief in bankruptcy.
Our firm has represented many business owners who personally guaranteed SBA loans, from Uber to restaurant owners. Not even taking into account that ridesharing has been an increasingly competitive and saturated business, many Uber drivers have found that Uber’s algorithm has been reducing the money they make over time, which has made it increasingly difficult to pay their SBA loans. Restaurants have traditionally been a business where it is very difficult to consistently make a profit. This is even harder when burdened with SBA loan obligations, especially for businesses that did not fully recover financially from the Covid pandemic.
If a business owner files for bankruptcy, how they utilized the SBA funds may potentially receive scrutiny. Improper use of SBA funds can be a basis for an adversary proceeding challenging the dischargeability of the debt or possibly a criminal referral to the Department of Justice, if warranted. There are surprisingly few bankruptcy cases in which the SBA sued a debtor in an adversary proceeding. See United States v. Klein, BK 22-40804 USBC, Dist. of NE (2022) (in a Chapter 12 case, debtor filed after their farm had been foreclosed. They intended to use SBA funds to start farming again. However, the Bankruptcy Court enjoined them from using the funds since they were not engaged in a farming business before filing the case. Furthermore, they had only used the SBA funds for legal fees, and not for their business.) and United States Small Bus. Admin. v. Vereen (In re Vereen) No. 20-80517 (Bankr. M.D.N.C. Apr. 4, 2022) (The Debtor used $71,000.00 from an SBA loan to purchase a 2012 Bentley Mulsanne and used $36,000.00 to purchase two trucks but was unable to explain what happened to the trucks. As a result, the Court denied his discharge). One reason why we may have seen just a handful of such cases is that the payments on SBA loans allowed for a two-year deferment period and for many only recently became due. Now that required payments have become due, many loans are already in default as business owners struggle to pay. Accordingly, we may see more SBA-related litigation in the Bankruptcy Courts in the near future.
What is the bottom line when dealing with an SBA loan in default?
Depending on the circumstances, bankruptcy may be the best option for a borrower with personally guaranteed SBA debt. It is available to all borrowers and all creditors are bound by the filing. Furthermore, it does not have all the stringent requirements of an offer in compromise or Hardship Accommodation Plans, both of which are difficult to obtain. Many debtors simply do not have the funds available to resolve the loan through an offer in compromise, whereas the HAP program is really intended for borrowers with short term financial difficulties. Furthermore, the HAP program is not ideal since interest will continue to accrue on the loan while the borrower is in the plan. If you are struggling with SBA debt, you should speak with an experienced bankruptcy attorney to review your options.
Contact The Law Offices of David I. Pankin, P.C.
At the Law Offices of David I. Pankin, P.C. we have over 28 years of experience helping small business owners file for bankruptcy and obtain a fresh start. If you have a personally guaranteed SBA loan and want to review your options, please feel free to contact our offices at (888) 529-9600 or by using our easy online contact form.
More information:
https://www.sba.gov/funding-programs/loans/covid-19-relief-options/eidl
https://www.forbes.com/sites/lensherman/2023/12/15/ubers-ceo-hides-driver-pay-cuts-to-boost-profits/
