If you are an investor in a company funded by a Small Business Administration (“SBA”) loan, then you may wondering whether you are liable for the company debt should the business fail. The Borrower is principally responsible for repayment of the underlying promissory note associated with the SBA loan, but what about shareholders and members (in the case of a limited liability company) — are they liable too? It depends.
Am I automatically responsible for the business debt if I am a shareholder?
No, shareholders who simply invested in the company are not automatically liable for the business debt of the company. This is true whether your business entity is a corporation or a limited liability company (“LLC”). A shareholder or member will not be liable, unless they sign an Unconditional Guarantee agreement for the SBA loan (SBA Form 148 in most cases). It is the guarantee agreement itself and not the fact they are a shareholder or member of the Borrower that creates the personal liability for the repayment of the SBA loan in the event of a default.
What is the magic percentage that triggers the SBA’s requirement for a personal guarantee on an SBA loan?
The SBA requires a personal guarantee from all owners with at least 20% ownership in the Borrower. This means of you are a stockholder or member in an LLC and own 20% or more of the company you will be asked to sign a personal guarantee.
What If my spouse owns 5% and I own less than 20%, will either of us still have to sign a guaranty agreement?
If a shareholder or member’s spouse owns 5% or more of the Borrower and the combined ownership interest of both spouses is 20% or more, then the spouse must also provide a full personal guarantee. This is set forth in SBA’s Standard Operating Procedures (SOP 50 10 5(J)).
What if I am a shareholder and I own 5% or less of the Borrower?
SBA Lenders may still require a guarantee from a shareholder or member’s spouse if they think it is necessary to perfect their lien on collateral pledged by a shareholder or member. In such cases, it may be that the lender will ask the spouse to sign SBA Form 148L which limits the spouses liability to their interest in specific collateral pledged by their husband or wife; this is called an Unconditional Limited Guarantee.
Yes, its is very likely, but not certain. If this is a concern, you should discuss with your attorney. Under the current law, an agency must deny credit to a delinquent, debtor unless this requirement is waived by the head of the agency or the Chief Financial Officer. The delinquency can be resolved or fixed by the debtor entering into a repayment plan for collection of the amount of the delinquency or by paying the amount of the delinquency in full.
Are there standards for determining if I will get a waiver?
Yes and No. This is a developing area and Treasury is working on guidelines for the agencies to use in setting their own standards for waivers. These guidelines will include the expectation that an agency will balance whether the denial of credit would be contrary to the purpose of the program under which the credit is being made against the intent of the law to ensure that the federal government does not continue to provide funds to known or repeat delinquent debtors.
Owners with at least least a 20% stake in an SBA loan financed business will be required to execute a personal guarantee. This means that, as an owner, you are promising to pay the SBA lender and/or the government in the event the Borrower (your business) defaults and can no longer make the loan payments. If you believe your business is in trouble, SBA debt relief options may be available that could release you from your personal guarantee, including:
(i) a loan assumption under which a third-party takes over your business and your SBA loan (in such instances you may be able to negotiate a release of your personal guarantee, but this is not automatic);
(ii) a sale of your business assets to a bona fide third-party for value followed by an offer to settle the remaining balance due – known as an SBA Offer in Compromise; and
(iii) a SBA loan modification, if your business can be saved by change in your loan terms. The SBA lender may agree to an SBA loan modification adjusting the balance, loan payment, term or the interest rate of your loan.
If you fail to honor your personal guarantee, the SBA lender can file suit against you in a court of law to collect the debt. Even if the SBA lender chooses not to do so, the SBA can also choose to do so, or the SBA may simply refer your SBA debt to the U.S. Treasury for collection through the administrative offset process. Once in Treasury, you may be subject wage garnishment as well. Therefore, if your business is failing, it essential that you understand your SBA debt relief options.
Get ahead of the problem before your SBA lender begins the SBA loan default and SBA collections process without hearing from you.
If you currently have an SBA Loan and you live in an area affected by a natural disaster, you may be entitled to relief. Hurricane, flood, wildfires, droughts, avalanches, landslides and earthquakes are just a few examples of the natural disasters that can cause the government to classify an area a natural disaster zone
The SBA disaster loan forgiveness program provides for loan forgiveness on a case-by-case basis. If you have a small business, you may qualify if your business was located in a declared natural disaster zone. If the SBA approves loan forgiveness, then you will not be legally obligated to repay the portion of your loan that was forgiven.
There is really no way to know. Period. There are so many variables:
1. Who handles your file;
2. What SBA office is handling your file;
3. Your level of cooperation with the lender, both real and perceived;
4. Whether you have liquid assets vulnerable to traditional collection methods.
In general, the following factors will impact the likelihood of settling with the SBA:
1. The amount of the Deficiency Balance;
2. Whether a Bankruptcy would shield some or all of the Guarantor’s assets;
3. The Guarantor’s net worth, including exempt retirement assets.
4. What would a wage garnishment yield over 5 years?
5. Is the Guarantor really likely to file bankruptcy or is it a bluff;
6. The Guarantor’s health or special circumstances (e.g., hardship);
7. The costs of collection, and in particular, the likely ROI on collection activities.
In short, the SBA, like the IRS, already sees the exposed assets you have pledged as the baseline of any offer. What they want is more. The SBA is looking for an Offer, usually a lump-sum offer, that is better than any alternative that can be obtained through enforced collection activities that consume time and money and may carry an uncertain outcome.
The hard truth is that thousands of businesses fail every year and not everyone will settle with the SBA. But, the SBA Offer in Compromise represents a powerful alternative to bankruptcy in many cases.
If you default on an SBA loan, your lender will frequently file a lawsuit against the borrower and all guarantors. The lender does this as part of a mandated process to maximize recovery before requesting the SBA to honor their loan guarantee agreement. However, we find that even at this stage, a lender will usually consider a reasonable offer in compromise from a guarantor. If the offer is accepted, the suit can be dismissed prior to the entry of judgement.
In many cases, lawsuits are never filed by the lender, but once the SBA pays the loan guarantee to the lender, the lender will assign certain rights to the SBA to collect on the Note and Guarantees. In such situations, the SBA itself may decide to take legal action against guarantors who have significant non-exempt property (e.g., stock portfolios, rental properties) and/or substantial incomes.
If the SBA refers a matter for a civil action, then the U.S. Attorney’s office, Civil Division, will likely prepare and file suit against you in federal court. This can be a shocking event, but it does not mean settlement is off the table. If you have been sued by the U.S. Attorney in federal court, you should consult with your attorney immediately. If you do not respond correctly or in a timely fashion, certain rights may be lost and you may have a judgment entered against you. The suit is a wake up call that the government considers the debt collectible and that previous attempts were perceived as either insincere or woefully inadequate given your income and assets.
How long does the SBA have to file suit?
The SBA has 6-years to file suit against a guarantor in the absence of other events or agreements that might toll (suspend) this period of time. The limitations period will be measured not from the time of your default with the lender, but from the time the SBA took possession of the Note. In short, the government will get its full 6-years even if the transfer of the Note occurred near the end of the lenders statute of limitations (governed by state law). Once SBA owns the Note, federal law will be applied to determine the limitations period and will control in any lawsuit.
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.
In general, you will need permission to sell your home if the SBA lender placed a lien when you took out your SBA loan. There are many circumstances under which you may need to sell a home with an SBA lien on it. Here are a few:
I am changing jobs and must move out of state and buy another home.
If you are not in default of your SBA loan, then you should talk to your SBA Lender about “Substitution of Collateral” and “Replacement Liens”. In certain circumstances, the SBA Lender may be willing to allow you to essentially swap collateral if, in doing so, its rights are not adversely affected. In some cases, the replacement property may, in fact, have more equity making the arrangement even more attractive to the SBA Lender.
Another common scenario is the need to sell a rental property which is simply not making money and provide the SBA Lender with a lien on another property you own that was not previously pledged as collateral. Again, if this arrangement will not adversely affect the SBA Lender, they may allow you to do so and thereby permit you to liquidate non-performing investment property in order to use the capital more effectively elsewhere.
I will lose my house to foreclosure if I don’t sell it, but there is not enough money to pay off my mortgage and the SBA.
Under certain circumstances, the SBA Lender may be willing to accept a short sale if not doing so would likely result in a worse recovery or perhaps no recovery at all. If you are in this position, be sure you determine what it will take to payoff all tax liens and prior mortgages on your home, then approach the SBA Lender with the best offer you can obtain for the property and an appraisal of the property. In many cases, if the deal makes economic sense, the SBA and the SBA Lender will agree to it.
In most cases people have invested a good portion of their life savings into the business now going under. Losing your business is a terrible thing. And, being faced with the prospect of repaying your SBA Business Loan with little or no savings and the loss of your business is daunting.
In a majority of cases, business owners opt to work with their Lender to put the business on the market and sell it to a third-party or simply liquidate the assets piecemeal. Here are a couple of common questions and the answers will probably surprise you.
Can I really do a better job than the bank in selling my business?
In almost all cases you can. Lenders are not in business of selling businesses, they make loans. They can repossess the collateral and, in rare cases, they could appoint a receiver to operate a business and then sell it, but in our experience, the business owner is in the best position to maximize recovery here.
If you can arrange for the sale of your business, you are likely going to avoid a brokerage fee of between 6-12% (or more). Or, if the bank repossesses the assets and auctions them the cost of doing so will get charged to the loan (increasing your balance). In many cases, auctioneers charge between 25% – 35% to auction off miscellaneous assets; those buying them are looking for bargains. If your business is a franchise, then the franchisor may want to place someone else in your location and this may also result in that party assuming (taking over) the ground lease as well.
If you are thinking about selling your business assets, talk to your Lender and your attorney and determine the best course of action.
Will the proceeds from the sale count against what I owe the Lender?
Yes. The purchase price will be applied to what the Borrower owes the Lender on the loan. But, be careful here. The assets belong to Borrower and the Borrower’s legal liability has been reduced, but if the proceeds from the loan don’t fully payoff the loan then a deficiency will result. In other words, the remaining balance must be paid — by the guarantors!
Won’t the proceeds from the sale of the Borrower’s assets count against my Offer in Compromise?
No, the balance you are compromising has now been reduced from X to Y because of the sale. As a guarantor you must now settle that liability yourself. For example:
1. The original loan balance is $100,000
2. The sales proceeds are $30,000
3. The Deficiency balance (whats left) is now $70,000
4. The credit you receive as a guarantor against your offer is $0; that’s right – zero.
As a guarantor, you must now make an offer to compromise your individual liability to the Lender under your guaranty agreement. This means that you, as a guarantor, must offer something more to settle the $70,000; this money must come out of your own pocket or be borrowed. It cannot come from any remaining cash in the business bank account or from the sales proceeds.
Before your discuss your offer in compromise with the Lender, talk to your attorney first. Ask how the proceeds from an asset purchase will be applied. This answer can come as a shock to a business owner who is losing their business and must now settle the remaining loan balance. Therefore, be sure you have a plan to fund your offer in compromise because selling the business only solves part of the problem, but will still leave you on the hook in almost all cases.
We are frequently asked by business owners whether they can sell their business assets after an SBA loan default. The short answer is – yes, but the longer answer involves working with the your Lender to get permission to do so. Under your security agreement the lender has what is known as a security interest.
What is a security interest?
In the context of an SBA Loan, a security interest is a legal right granted by the Borrower to the Lender over the Borrower’s property (usually referred to as the collateral). The security agreement provides the Lender Bank with recourse to the property pledged as collateral, if the debtor defaults in making payment or otherwise performing the secured obligations.
How do I know if my business assets are pledged?
Any Borrower closing an SBA loan should expect the Lender to place a blanket lien against the assets of the business. Lenders will file a UCC-1 financing statement. This form is filed in order to “perfect” a creditor’s security interest by giving public notice that there is a right to take possession of and sell certain assets for repayment of a specific debt with a certain priority. You cannot sell assets subject to such a security interest without first paying off the loan giving rise to the security interest in full or getting permission from the Lender to to do so.
I have a buyer for the business assets. What can I do?
If you want to sell the assets of the business to help pay down the loan, you should discuss this option with your attorney before making a commitment to any party to do so. Your attorney may suggest drafting a non-binding letter of intent (LOI) and forwarding this to the Lender for review. Lenders liquidating collateral must take care to act in a prudent manner or risk losing their SBA guaranty rights. Therefore, a Lender will want to compare the offer in the LOI to their appraisal numbers before approving a sale.
You should avoid signing any contract for the sale of your business assets unless your attorney has reviewed it first. In many cases a “condition precedent” to closing the sale should require a written consent by the Lender approving the terms of the sale – in particular, the sale price and the list of assets being sold.
What if my offer is not accepted by the Lender?
If your offer is not accepted by the Lender you should discuss this fact with your attorney. Without the Lender’s consent to the sale, they will not release the lien placed on the business assets and you will not be able to grant the buyer good clean title to the assets; this is something the buyer expects. In most cases, the buyer’s attorney will have required a representation and warranty from you that you do indeed have the ability to give the buyer title to the assets free and clear of all liens.
Asset Sales are Common, but Use Caution.
If you sell your business assets to a buyer without first obtaining bank approval, you may be subject to suit from the buyer, the Lender, and the SBA (in some cases, your actions may trigger prosecution for a criminal offense). Therefore, it is critical that you act carefully and seek qualified legal counsel to help you review offers from any prospective buyer.
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.
Owing the federal government a debt can be a frightening experience. Once your defaulted SBA loan makes it was to the Treasury, it is likely that you will soon be contacted by one of the collection agencies that handles the collection of government debts. The calls and the letters can be intimidating, but more dangerous can be the entreaty to simply setup a payment plan to pay an amount you can afford. While this is not always a bad idea, it is important to understand the risks. A collection agency may threaten wage garnishment, a remedy that is allowed under federal law, even if your state’s law would ordinarily bar it. However, if you simply make voluntary payments you need not worry about the trauma and embarrassment of administrative wage garnishment. This sounds appealing and perhaps even a reasonable bargain, but is it?
If your SBA debt is very old, it may be that the SBA and Treasury no longer have the right to file a lawsuit against you. This concept is called a limitations period or statute of limitations and this limits the time a creditor has to file a lawsuit against you. However, if you are in a state where your homestead equity is not completely protected, a lawsuit might result in a judgment against you. With a judgment in hand, the government could, in fact, quite possibly force the liquidation your home. Even though you did not pledge your home as collateral for the SBA loan, the judgment may give them the power to take what they otherwise could not reach. Fortunately, the SBA has only 6 years to file suit (how to measure this is something to discuss with your attorney). But, if you make a voluntary payment to the government, even if this period has expired, it is possible that you will revive the statute of limitations. If you do so, you may open yourself up to a lawsuit where previously none was possible.
When the government’s collection agency says only pay what you can afford, the price for peace of mind may end up costing you far more than you can afford. If you receive a notice or collection letter purporting to be collecting on a defaulted SBA loan, contact your attorney before making any admissions or payments to the collection agency. Have your attorney explain the ramifications of entering into the payment plan and be sure it is in your best interests to do so. Payment plans are not always a bad idea, but forewarned is forearmed.