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.
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.
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.
There’s no way around it: divorce is stressful. During this often ugly process the soon to be ex-spouses battle it out and in the end arrive at a division of property and debt that they both agree upon. It is on the assumption that this hard-won agreement represents the last word on their personal liability for martial debts that most people depend. Sadly, these agreements are not worth very much when the obligor’s finances deteriorate.
Joint and Several Liability
Whether or not your ex-spouse agreed to be solely responsible for an SBA Debt, if both spouses were guarantors on the SBA loan, then the SBA has a right to pursue either spouse for the full amount of the outstanding debt; this sad fact is a result of what is referred to as joint and several liability. And, although the SBA can only collect the full amount of the debt once, both ex-spouses remain guarantors on the original debt — that is, unless one of them settles with the SBA first.
That Hard-Won Agreement with your Ex-Spouse is Not Binding on your Creditors
The simple fact is that you divorced your husband/wife, not your creditors; they were not parties to your divorce and had no say in your agreement. Therefore, agree all you like with your ex-spouse, if he or she fails to pay off the full balance of the remaining SBA debt, you will be asked to do so. In many instances, years can pass before the SBA gets around to sending a 60-day Notice Letter making the event all the more traumatic with many a person prone to ignore it. But, it would be a grave mistake to ignore this notice — it may well be the only opportunity for you to settle the debt on reasonable terms before it is transferred to the U.S. Treasury where settlement terms are harsh and deals few and far between.
The financial collapse of a family business can often lead to divorce. Work out a realistic plan to address the SBA debt or the U.S. Treasury will ultimately work one out fore you.
Forewarned is forearmed.