During the COVID pandemic, many small business owners obtained loans from the Small Business Administration (SBA) through the Economic Injury Disaster Loan (EIDL) program. Due to numerous factors, including but not limited, changes in the marketplace, inflation, supply chain issues, or simply the risks of running a small business, many of these businesses have failed or are struggling financially. It is estimated that SBA loans in the EIDL program presently have a very high default rate of approximately 37%. As a result, many business owners who are personally liable for their SBA loans are now contemplating filing for bankruptcy to help obtain the debt relief they need.
Are SBA Loans Dischargeable in Bankruptcy?
Increasingly, we have been contacted by debtors struggling with SBA loan payments who have been asking “can an SBA loan be discharged in bankruptcy”? The good news for debtors with a failed or struggling business is that bankruptcy can discharge SBA loans. Typically, a business owner is personally liable for an SBA loan when the amount they borrowed was over 200k or their business was unincorporated, and they signed personally for the loan. While many distinct types of business met the SBA loan requirements and obtained loans during the Pandemic, some of the most common types of businesses we have seen that are in need of debt relief are Uber and Lyft rideshare drivers, restaurants, and transportation-related businesses.
Whether the SBA debt is secured or unsecured, personally guaranteed or in the business name only, it does not fall into any applicable statutory exceptions to discharge, such as government fines, domestic support obligations, criminal restitution or fines, and taxes due within three years of filing. See 11 USC §§ 507, 523, 727, 1322, 1328. Both Chapter 7 and Chapter 13 bankruptcy allow a debtor to file a petition and receive a discharge of their debts, including SBA loans. If a debtor with SBA debt is struggling financially, bankruptcy can be an effective way to discharge the debt from an SBA loan or series of loans. 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.
In a Chapter 7 bankruptcy proceeding, a debtor can quickly eliminate their debt and obtain a fresh financial start. If the business owner is filing and it is not financially realistic to keep the business operating or the business is already closed, then Chapter 7 bankruptcy may be the best option if the debtor qualifies. Keeping a business open after discharging SBA loans may be difficult since many SBA loans are secured against the assets of the business. This means that if the loans are not paid, the SBA can repossess the assets of the business and liquidate them to recoup the debt. The lien that the SBA has against a business is not affected by bankruptcy discharge and can be enforceable upon completion of the bankruptcy case.
If a debtor has a majority of consumer debt as opposed to business related debt, then they may be subject to the Bankruptcy Means Test to qualify for chapter 7 bankruptcy. However, many debtors with SBA loans have a majority of business debt and are not subject to the Means Test, but they still must be able to show that they do not have enough surplus income in the monthly personal budget to potentially fund a Chapter 13 plan.
A Chapter 7 debtor can protect their exempt assets using the applicable set of bankruptcy exemptions. In New York, a debtor can typically protect their household goods and electronics, a motor vehicle, a certain amount of equity in their home, retirement accounts, such as 401k, 403b, IRA and pension accounts, life insurance, worker’s compensation awards, certain value in a personal injury case, and money in the bank up to the limit of allowable exemptions. Although, if a debtor has assets that are not covered by the allowed exemptions or if their income does not allow them 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 interest-free for most debts. Once approved by the Bankruptcy Court, all creditors must accept it. In the plan, the debtor pays the claims of their creditors, and depending upon various factors, may only pay back a percentage of the debt that is owed. However, if a debtor is above the debt limits for a Chapter 13 case ($465,275 for unsecured debt and $1,395,875 for secured debt), then they would be restricted to filing for Chapter 11 bankruptcy or a small business bankruptcy under Subchapter V.
The SBA May File an Objection to Discharge if the Debtor Misused the SBA Loan Funds
If a business owner files for bankruptcy, how they utilized the SBA funds may potentially receive scrutiny. The SBA can request testimony and documentation through a proceeding called a Bankruptcy Rule 2004 Examination. The SBA can also compel that a debtor produce documents to demonstrate how the SBA loan proceeds were spent, if necessary.
If a business owner is unable to demonstrate how the loan proceeds were used or if they were used improperly, they may be subject to a lawsuit in the bankruptcy court called an adversary proceeding objecting to the discharge of the subject SBA loans. Improper use of SBA funds can also be a basis for a criminal referral to the Department of Justice (DOJ), if warranted. If the debt is found to be non-dischargeable due to misuse or abuse, then the debtor would still owe the debt even though they filed for bankruptcy and possibly received a discharge on other debt. According to the Governmental Accountability Office (GAO), the DOJ has focused on the Paycheck Protection Program when prosecuting fraudulent loans, but also reviews and prosecutes fraud involving the EIDL program. In those cases, DOJ has charged individuals with “misrepresenting eligibility, falsifying documents, using stolen identities,” and “deliberately exploiting the programs by conspiring with each other, sharing knowledge on how to circumvent controls, and obtaining kickbacks.”
Bankruptcy May be the Best Way to Resolve SBA Loans
Bankruptcy is often the best debt relief option for a borrower that is struggling with personally guaranteed SBA. This is especially true for a borrower of an SBA loan that has either closed the business or is in the process of closing the business. Bankruptcy is available to all borrowers and all creditors are bound by the filing, including the SBA. Furthermore, it does not have the harsh requirements of the difficult to obtain bankruptcy alternatives such as an offer in compromise or a Hardship Accommodation Plan. Bankruptcy, on the other hand, provides debtors with a complete and relatively quick fresh start.
At the Law Offices of David I. Pankin, P.C. we have over 28 years of experience helping small business owners file for bankruptcy. If you have an SBA loan and are considering filing for bankruptcy or want to review your options, please feel free to contact our offices at (888) 529-9600 or by using our easy online contact form.3
More information:
https://www.sba.gov/funding-programs/loans/covid-19-relief-options/eidl
https://www.justice.gov/usao-edla/pr/laplace-woman-indicted-false-statements-small-business-administration-and
