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.
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 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.
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.
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.
Scenario 1. My business may close because I don’t have enough working capital.
If you are facing an SBA loan default, then you may want to consider selling your business. If your business has a good track record, but your business is starved for working capital, a loan assumption may be an option. In some cases your loan may be assumable by a third-party buyer who can then step into your shoes, purchasing both the assets and assuming the debt creating a win-win for you and the bank.
Scenario 2. My business is doing well and we want to sell, but we have an SBA loan outstanding.
When you start a business, apart from the income it generates, there is always a need for an exit strategy. It may be that you need to move to take advantage of new opportunities or simply retire. When you have an outstanding SBA loan, you may be able to work with your bank to sell the business and achieve those goals. However, as with the first scenario, you need to be sure you really have “exited” and that no further personal liability exists under the unconditional personal guarantee you signed when the SBA loan was originated.
My loan was assumed, so why should it matter if the new borrower defaults?
Your bank will likely be happy to help facilitate a loan assumption to avoid a default. And, you banker may also be willing to work with you to help facilitate an exit for retirement. Certainly, this sounds like a win-win situation for all parties. However, the devil is in the details. It is important that you work very closely with your attorney to ensure that the SBA actually releases you from the unconditional personal guaranty you signed when you originated the loan. One would think that would be the default result, but that is not the case.
If the new borrower defaults, the bank may certainly pursue them and the new guarantors; however, if neither the new borrower or the new guarantors pay up, and instead file bankruptcy, then the bank may still have recourse against you. In order to avoid this dire situation, you and your attorney should read the fine print of the legal documents together and confirm that you are expressly released. Your banker may also think that that you are released, but it is the fine print in the final documents that count. Remember, the bank, well meaning or not, does not represent you. You must look to yourself and your own attorney to protect your interests.
If the Small Business Administration (SBA) has accepted your offer in compromise, then congratulations are in order. But, be warned, you must follow the terms of your offer precisely and make all payments on time or risk default. In many cases we are approached by well intentioned people who established settlements with the SBA calling for payment of the settlement in equal consecutive monthly installments; however, for one reason or another they missed a payment or two. Missing a payment can have disastrous consequences and result in a referral to Treasury, the imposition of additional collection fees adding nearly 30% to your original debt, less a credit for your prior settlement payments and the resumption of interest on the uncollected balance (this assuming the SBA agreed to zero interest settlement for you).
I knew a default was bad news – what can I do?
If you have been advised that your SBA OIC is in default you must act quickly. It may not be possible to get the original settlement back by simply making up the missing payments and a new SBA Offer in Compromise may need to be submitted. There are simply too many variables in these cases and consulting a licensed attorney with experience in this area should seriously be considered.
Missing a payment and paying ahead are both equally dangerous
How can paying ahead be bad? When the SBA accepted your offer to pay in installments, it programmed its computers to look for payment in accordance with its terms; in most cases equal, consecutive, monthly payments of an exact amount are called for under the agreement. Many people concerned about defaulting think that paying ahead can protect them from default by establishing a cushion of sort. However, that is a very dangerous train of thought. In fact, all you will do is pay down the balance and in effect short the remaining duration of your agreement (much like paying a mortgage off earlier), but the next month’s payment will still be due. When the SBA’s computers fail to register payment, you are at risk of default and the account may be referred to Treasury (this process is highly automated).
If you have paid ahead on your offer, but nonetheless received a notice of default, you should contact the SBA at once and explain the situation or consult with a licensed attorney experienced in this area. Although it may seem unfair, the government may strictly enforce the terms of your settlement to the letter. Instead of appreciating the gesture on your part, they may refer the debt to Treasury! Remember, SBA computers do a lot of this work and once transferred to Treasury, the SBA staffers may be unwilling to even discuss the matter.
Can I pay off my settlement early?
If your payment will completely pay off your settlement, then you may be able to do so safely, but you should contact the SBA or advise your attorney before doing so. The terms of your offer control and making a mistake can cost you dearly.
Before referring a debt for collection by administrative offset, a creditor agency must provide each debtor with:
(a) a written notification of the nature and the amount of the debt, the intention of the agency to collect the debt through administrative offset, and an explanation of the debtor’s rights;
(b) an opportunity to inspect and copy the records of the agency;
(c) an opportunity for review within the agency; and
(d) an opportunity to enter into a written repayment agreement.
Can they offset my tax refund and then tell me after the fact?
Yes, after the debt has been referred for administrative offset and an offset is taken, the disbursing official conducting the offset must notify the debtor/payee that the offset has occurred (including the amount and type of payment that was used to pay the debt) and the identity of the creditor agency requesting the offset, including a contact name. The specific timing of the notice is not mandated for tax refund offsets.
What if I did not receive a notice at all?
Regardless of the type of payment, failure of the debtor to receive notice will not affect the legality of the offset (withholding).
Is it true that I will be barred from accessing SBA loan programs in future if I don’t pay my debt in full.
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.
As a general rule, more so now than in the past, the Small Business Administration (SBA) will direct a Guarantor to submit their SBA offer-in-compromise package to the lender for preliminary review and approval. In fact, not in every office, but in some, lenders will be given just 10-days to get the job done. It is not that the SBA is trying to be unkind, but if lenders what to support the deal time of the essence. Now, if for some reason the lender can’t or simply won’t cooperate in the process, SBA will usually take on the responsibility of doing the entire review and work out the particulars with the lender following their own internal process. But, what if the lender just won’t play ball?
My lender has refused every offer I have made?
First, make sure your packages are complete and your offer is serious. If you are working with a professional, they will know how to prepare your offer package and what is expected by the lender and the SBA. Where we see the most mistakes involves a blind appeal for sympathy. Folks, its not that the SBA analysts aren’t human; we work with them every day and the human factor comes into play all the time. But, the guidelines under which they operate require a stringent review of your financial condition. In short, your offer has to present itself as a better alternative to anything else the government is likely to collect from you through enforced collections. In many cases, administrative wage garnishment (AWG) makes it likely that a substantial percentage of the debt might be collected over your working lifetime. Therefore, if your offer has any chance of success it must, at a bare minimum, take that calculation into account.
Second, make sure you are really putting your best foot forward. If you clearly have assets and are unwilling to borrow or at least consider partially liquidating them to support your offer, the SBA may consider the offer insincere — at least, that is my take. So, don’t bother low balling the SBA, unless the rationale for the low offer would make financial sense to the analyst.
Finally, if the lender tells you the offer is just not enough, then look for a way to improve it, or you may end up in Treasury.
Do I really need the lender’s approval?
Yes, in the vast majority of cases, if your lender will not support your offer, the battle is lost. Gaining the support of your lender does not assure acceptance of your offer by the SBA, but failing to secure their recommendation in support of your offer all but assures its rejection. You may be under a lot of stress, but never never yell at your banker; it won’t help and can make things worse. The SBA Offer-in-Compromise package still requires a lot of work on your bank’s part, if they choose to recommend it for approval. Do not give your banker, who may be short-staffed, another reason to put your file on the corner of his her desk in the “I will get to it later pile”. Remember, you are asking the lender to help you and whatever other feelings you may have at the time, you need that help.
The lender’s just doesn’t like anything I suggest. I think they are being unreasonable.
In my experience, lenders rarely turn down a good offer. After all what’s not to like about recovering more money on a bad loan? Sadly, in some cases, lenders may have all but adopted a no settlement policy. A loan committee may have unrealistic expectations that the Guarantors simply cannot meet or may simply have a sour taste in their mouth based on the loan history or their interactions with the Borrower and Guarantors. Sometimes, it just feels personal and it may be.
Can the bank just refuse to settle?
Yes, the SBA, in my experience, will not question a bank’s refusal to settle. Only in certain situations where a bank refuses to review an offer within the time provided by the SBA will some SBA offices take over the offer review process. I am led to believe that, in those few cases, the bank may be asked by the SBA to essentially waive its right to any part of the recovery. Hence, at that point the bank’s consent no longer has any real bearing on the approval by the SBA.