In many states, it is standard practice for an SBA lender to ask a loan guarantor to pledge their home as collateral in connection with their unconditional guaranty. If the business loan you guarantee goes into default, your homestead could be at risk of foreclosure. However, the SBA may not always urge a lender to foreclosure on your home, even if the SBA and the SBA Lender have a legal right to do so. Here are a few factors that may impact this decision:
Do you have a first mortgage on your home ahead of the SBA loan? This may help you.
The general rule in property law is that liens have priority in the order that they are filed in the county records office. This is known as the first in time, first in right rule. Based on this principle, a recorded interest has priority over later recorded interests. If your first mortgage is ahead of the SBA loan, it will make foreclosure less attractive to the SBA Lender since foreclosure proceeds must first be applied to payoff the first mortgage entirely, plus the costs of foreclosure before the second mortgage holder receives anything.
If your home equity is zero or very low, it may be that the SBA lender will choose to do nothing for now and wait hoping the home will increase in value over time. In many cases, if this occurs, a foreclosure may not be initiated for years and then only if the value of your home has substantially increased and some factor has brought this to the attention of your SBA Lender or the SBA.
What is Home Equity?
Home equity is the market value of a homeowner’s unencumbered interest in their real property, that is, the difference between the home’s fair market value and the outstanding balance of all liens on the property. For example, if your home is worth $225,000 and you have a first mortgage to Bank X for $100,000, then you have $125,000 of “Equity” in your property and, in an SBA default situation, that might tempt the SBA Lender or the SBA to foreclose. However, if you add a second mortgage of $75,000, then you only have $50,000 of equity in your property and, in a foreclosure setting, this may not be enough for the SBA Lender (in a third position behind your second mortgage) to foreclose. Be sure to review all your mortgage debt with your attorney if you are discussing the consequences of an SBA loan default.
Can I make the SBA or the SBA Lender an Offer to Release My Home as Collateral?
Yes, you can make the SBA Lender an Offer in Compromise to settle your total liability associated with your personal guaranty or you can just make an offer for the release of the lien on your home. But, use caution. If you obtain a release of SBA Lender’s lien on your home without also completely settling your liability under your personal guaranty, you might later be sued by the SBA Lender. If the SBA Lender obtains a judgment, and then places a judgment lien on you real property, your home may be at risk all over again.
Handling the release of an SBA lien on your home correctly may require professional assistance. It is important to consider this action as a part of your overall strategy. In many cases, it may be possible to combine the release of the lien on your home as part of your complete offer in compromise settlement package. But, many variables can affect the outcome, so be sure to discuss your goals completely with your attorney and/or CPA.
Many people contact our law firm after receiving an SBA 60-day letter demanding that they pay the entire amount due under their company’s defaulted SBA loan. And, time and time again, we hear, they protest claiming they only own 25% percent of the company and so should only be responsible for 25% of the debt, if any at all. In fact, most ask why if the company is a limited liability company (LLC) they should owe anything at all. The problem: the unconditional guarantee they signed.
Ordinarily, a member of an LLC will not be liable for the debts of the company, especially if they sign documents in their capacity as a Manager of the LLC and not as an individual. However, when one signs a personal guarantee that all goes out the window. Not only are you liable to repay the Lender and/or SBA if the company fails, but your liability is joint and several, meaning that the Lender and SBA can come after any one of you for all of the debt not just part of it. In short, your percentage of ownership has nothing to do with the extent of your liability.
Although the SBA tends to issue demand letters to all guarantors, when your loan first goes into default, the lender may sue the Borrower and all guarantors and then obtain a judgment. In some cases, the lender will pursue collection of the judgment, right away, particularly if they know that one or more of the guarantors have a substantial amount of non-exempt (unprotected) real estate with equity or a large stock portfolio not in their 401K. If this happens, the Lender might even recover most if not all of the debt from one member, leaving the others largely unscathed. In that event, while the one member may be able to seek contribution from the others, that problem is theirs alone to sort out.
Before you sign that unconditional guarantee be sure you understand what might happen if the borrower defaulted. How are you positioned relative to the other guarantors? Who is going to get hit the hardest — is it you? And, are all the members ready to share the pain with you? Its not a happy thought, but its better all guarantors consider this situation before they sign.
The SBA expects every 7(a) loan to be fully secured. Although, the SBA will not decline a request to guarantee a loan if the only unfavorable factor is insufficient collateral, provided all available collateral is offered. But, every SBA loan must be secured by all available assets (both business and personal) until the recovery value equals the loan amount or until all assets have been pledged (to the extent that they are reasonably available).
What ownership percentage triggers a personal guarantee requirement?
In many cases, prospective clients approach us to ask about the SBA’s personal guarantee requirement. In some cases, the inquiring party is just a minority owner and not even actively involved in the business. Regardless of day-to-day involvement, all individuals who own 20% or more of the equity of a business applying for an SBA loan must provide an unlimited full personal guarantee of the indebtedness on SBA Form 148 or an equivalent document. Moreover, each spouse owning five percent or more of the business must personally guarantee the loan in full, if the combined ownership interest of both spouses is 20% or more.
My spouse is not an owner in the business, why is she being asked to sign a guarantee?
Personal guarantees may be secured or unsecured. If real estate, for example, is being pledged by one spouse, the other spouse may have an interest in that property that would make enforcement of the lien problematic if he/she did not approve the transaction. Therefore, non-owner spouses are of often asked to sign “Limited” guarantees that provides for liability up to the amount of equity in a specific piece of real estate.
Neither I nor my spouse together own more 20% or more of the business, why are we being asked to sign a guarantee?
Although the SBA requires guarantees for all owners meeting the criteria we noted above, lenders are free to require personal guarantees of owners with less than 20 percent ownership and liens on personal assets of the principals may also be required. In these cases, though, you may have far more room to negotiate this point with your lender since this is not an SBA requirement and left entirely to the lender’s discretion.