Financing a business is hard enough to begin with. Getting approved is tough, especially for a new company, and securing good terms is an even bigger challenge. The obstacles can seem endless. But then it happens. You miss a payment. Can the business lender sue? Did you get in too deep?
The short answer is yes. A loan company knows they have a right to take legal action against you after you default. But not all companies are going to sue. And when they do sue, you have to be prepared. Just like you should always know the terms of your loan before you take it, you should understand the potential consequences.
A Default Occurs
Many business owners misunderstand the term, “default“. A loan agreement is essentially a contract between the borrower and the lender. When you sign that loan agreement, you agree to specific terms. You are obligated to make the payment(s) according to the schedule outlined in the agreement. A default occurs when you fail to do so. How soon does a missed payment turn into default? Some lenders will consider your account in default after you miss just one payment, and some won’t change the status of your loan from delinquent to default for as long as six months of missed payments. So you always have to check the terms of your agreement.
Personal Guarantee
Whether a lawsuit can reach you personally, and not just your company, depends largely on whether you signed a personal guarantee. When a small business applies for an unsecured loan or a business credit card, the owner is often asked to give a personal guarantee. Think of a personal guarantee as your lender’s safety net. When you sign one, you’re telling the bank, “If my business can’t pay this debt, I will.” This means the lender can look to you, and your personal finances, to cover what’s owed. If the owner can’t or won’t pay up, the lender can sue and get a court order to collect. Owners of sole proprietorships also need to use personal assets if the business can’t repay its debts.
Keep in mind that not all business loans are created the same. You’ve probably heard of a secured loan. It’s a loan for things like equipment or real estate where you pledge the asset as collateral. That way, if you default, the lender can go ahead and seize the asset to recover its money. But what if you have an unsecured loan? Unsecured loans don’t carry the same risk, but the lender still may try to get their money back through other means, like a lien.
If a lender manages to sue you and win a judgment, they may be able to garnish your wages, your tax refunds, and even your personal bank account. Meanwhile, interest and late fees keep growing the longer you wait, so the longer the delay, the worse your debt gets. Defaulting not only hurts your business credit score, making future loans more difficult, but many lenders report the default to consumer credit bureaus as well, which damages your personal credit score.
You might not be in default yet, but if you’re worried you’ll start missing payments, it’s time to pick up the phone and call your lender. You may feel awkward admitting things aren’t as smooth as they could be, but the sooner you handle it, the more you and the lender benefit. They might offer a modified payment plan, forbearance, or even a lower interest rate. That won’t lower what you owe, but it does give you some breathing room to get back on track.
Collection Agency
When you are in default on a loan and the lender sells the debt to a collection agency, you’re now dealing with a company that bought the right to collect your debt for pennies on the dollar. The collection agency will try to collect the original amount due. When the collector calls, ask to verify the debt. The law requires the agency to send you a written validation letter within five days of first contacting you. You have 30 days to dispute. Review the debt validation notice you receive. You can dispute any debt you don’t know about or don’t believe is owed. If the debt is legitimate and yours, you may be able to negotiate a settlement for less than the full amount.
Debt settlement is an agreement with a creditor to pay a reduced amount. In many cases it could save you hundreds or even thousands of dollars. You can negotiate with a debt collector yourself, but it usually works better to let a debt settlement company or law firm handle it. Professionals know how settlement works and what tactics collection agencies use. Someone who has dealt with collection agencies for years, such as an attorney, can also help you understand and protect your rights.
If a collection agency files a lawsuit against you, don’t just ignore it. If you do, the court could enter a default judgment against you, handing the agency exactly what it wants. Instead, get an attorney to help you respond. Even then, you may still be able to work out a settlement.
So yes, a business lender can sue after default, and a personal guarantee or a sole proprietorship can put your personal assets in the line of fire. Therefore, it is important for businesses to communicate with lenders before falling behind on payments and explore all available options for resolving the debt. If you’ve already defaulted, learn your rights in the collection process and consider getting help to negotiate. And if you’ve been sued and are facing garnishment, work with an attorney to protect yourself and your assets as much as possible. Knowing what to expect when it comes to your business loans can be a huge part of the solution.
