A creditor lawsuit is usually the end result of a long process. More often than not, the lawsuit stems from an SBA loan. The missed payments, the default, the demand letter, the taking of the collateral, and then the lawsuit. Knowing where you are in the process will tell you where you have to go next. Above all, don’t panic.
What should you do when your business has been sued by a creditor? The first step is to know who is suing you and for what reason. We go through the steps one by one, including where the lawsuit comes in, what a judgment really means for you, and what the SBA can do after the lender is finished. We also lay out your options at each stage, including the Offer in Compromise and bankruptcy.
SBA Loans
When most people think of SBA loans, they picture a federal agency going around handing out loans. The truth is the SBA more commonly guarantees a loan made by your local bank, insuring them for up to 85% of the original balance. The SBA only lends directly in limited circumstances: as an Economic Injury Disaster Loan (EIDL) or as a Physical Disaster Loan. In such cases, the SBA must determine that the business can’t get credit elsewhere before it loans the money. New COVID-19 related EIDL applications have been closed since January 2022. Whether your loan came from a bank or straight from the SBA shapes everything that follows.
Missing a few loan payments might make you delinquent on the loan, but it doesn’t mean the loan is in default. That typically happens after 120 days without any payments at all. The reasons the loan might be in default could be a number of things. You might be having cash flow problems, there could have been an economic downturn, the marketplace could have changed or you might be struggling with some sort of operational setbacks. The lender usually will try to reach out to the borrower to work something out to bring the loan current. This is the time to reach out proactively before the loan goes into default, before the lender files a lawsuit.
There are a few ways to get out of a situation when you’re about to default, though none of them are automatic or guaranteed. First, you can apply for a deferment, also known as a forbearance. That is temporary payment relief and generally for no more than six months, but the lender has to be convinced it will help improve the cash flow situation so that you can resume payments. Next, a restructuring is an option, where the lender agrees to change the terms of the loan, which could include extending the repayment period or adjusting the interest rate. Finally, a lender may agree to accept an offer in compromise, which is a lump sum in exchange for the cancellation of the entire loan, but the lender will require a lot of financial information from the borrower and guarantors, as well as the liquidation of collateral.
Formal Collection Process
The moment your lender marks a loan as formally in default, the first thing you will likely see is a demand letter. A demand letter is the first step in the formal collection process. It is intended to put you on notice that a failure to pay your loan could result in serious consequences. In that letter, it declares the loan in default and demands immediate repayment of the full balance. Depending on the terms of the loan, the lender is obligated to give you a window to pay it in full, usually between 30 and 45 days. Once that deadline passes, it moves to seize the collateral, which could include business bank accounts, accounts receivable, real estate, machinery, inventory, and equipment.
A lawsuit can come into play when a lender seizes collateral from a company that defaulted on a loan. It can be part of the foreclosure against real estate, or it can come after collateral is sold to determine the deficiency if the collateral didn’t bring enough to pay off the loan. If you’ve been served, the key is to figure out which type of lawsuit it is and what stage you are at.
A judgment doesn’t just go away. In New York you can enforce a judgment for up to 20 years. It can be used to place a lien against other pieces of real estate that the debtor might own. This is the stage at which most local lenders begin to recover their remaining insured balance from SBA, and they turn the rest of the debt over to SBA. So the lawsuit is not the end of the story.
Direct SBA loans work much the same way, but the SBA has a few tools a local lender doesn’t. SBA says collateral has to be sold and the proceeds turned over to the government. If the proceeds don’t cover the balance, the SBA may consider an Offer in Compromise. That program is for borrowers who are facing financial hardship. If you meet certain criteria, the SBA will accept less than the full amount owed. Just remember, you need to document everything. The SBA will have to be convinced that the business is shut down and the collateral liquidated, and that your personal financial picture is bleak.
If an Offer in Compromise is not successful, the SBA can send a notice to the Treasury Offset Program (TOP) and/or Administrative Wage Garnishment (AWG) notice directly to your employer. The TOP allows the federal government to take a portion of any federal wages or Social Security benefits that are otherwise owed to you. In addition, the TOP can seize in full any vendor payments and income tax refunds you are owed. The AWG garnishment is up to 15 percent of your “disposable income” (which is essentially your net pay after deductions).
When you default on a loan from a local lender or the SBA, that lender has six years from the date of default to sue you and get a judgment. With a TOP or an AWG, there is no statute of limitations. Either one can begin more than six years after the default, and it stays in place until the debt is paid in full, including interest and collection fees. Trying to ‘wait it out’ is not an option.
You’ve Been Sued
Now that you’ve been sued, what should you do?
- First, you need to find out who is suing you. Is it the local bank, or the SBA?
- Second, you need to find out what kind of lawsuit it is: foreclosure on the real estate, or a deficiency lawsuit after the collateral has been sold?
- Third, be realistic: once the business is closed and the collateral is gone, an Offer in Compromise may be an option. If not, bankruptcy.
Don’t count on time being on your side.
If you are already in a formal default situation, declaring bankruptcy is one option that works fairly well. It is a powerful tool for business debtors and guarantors. It lets you reorganize business operations to cure the default and continue operating. Or it can clear out the debt entirely if the business is closed and repayment is no longer possible. Bankruptcy stops collection activity, including TOP and AWG.
Being sued is no small matter, but it doesn’t have to be the end of your business. There are multiple ways to handle a defaulted loan payment, and they involve proactive communication, strategic negotiation, and careful financial planning. Know your options, and take decisive action to protect your business. Ignoring the issue is never the answer.
