Many merchants who are struggling to repay a loan, especially after the missed payment that takes the loan into default, see the situation as hopeless. They believe there is no way out. But this is often not the case. In plain terms, settlement is negotiating with a creditor to accept less than the amount owed. The settlement process can begin well before the debt has gone into default or after it has. Whether it works for you depends on how much money you owe, what type of loan you had, and what your creditors are willing to accept.
When a Missed Payment Becomes a Default
You are considered delinquent as soon as you miss a scheduled payment. Being in default is a more serious situation: it means you have violated the terms of the loan agreement, and the lender is now free to exercise its full range of remedies, including accelerating the balance, seizing collateral, or taking legal action. When a missed payment becomes a default depends on your loan agreement. A covenant violation or a change of business ownership can also trigger a default, so it is possible to be in default while you are still making timely payments.
After default, expect calls, letters and texts. Since the Fair Debt Collection Practices Act doesn’t cover business debts, there are fewer limitations on when or how often a collector can call you to pursue your business loan. The lender may also sue. If a lender files for the full amount owed then it might win the lawsuit, but it will still need to spend time and money to collect on that amount. If your loan was secured, the lender can go after the collateral. Some lenders will file a UCC lien that extends to more business assets, such as your accounts receivable. Then there is the personal guarantee. Often business owners don’t realize they have signed a personal guarantee on loans. If the business doesn’t repay the debt, the lender can come after the owner’s personal assets to recoup the loan.
Lenders are more likely to let a debt go when there’s no personal guarantee, no collateral and little left in recoverable business assets. So why would the lender waste time chasing what it knows is uncollectable? Often the lender realizes it would be better to get something than nothing. How much will it take? It really depends on the particular case and the facts of the deal. It varies from lender to lender and business to business.
Many owners who fall behind are pretty confident that their company can pay it back – that they can come up with the cash to recover the situation. But that may not be the reality. Be realistic about how much money you have to offer and what you can afford. A workout, such as forbearance, deferment or a modified note, may give you breathing room to pay off the debt in full but doesn’t make it any less. It’s only in a settlement that the lender is getting less than what it is owed.
An SBA Loan Goes Through the Offer in Compromise
SBA loans work differently, because the federal government stands behind the debt. With a 7(a) loan, the SBA never loaned the money; it’s a bank that loaned the money with an SBA guaranty behind it. After the bank does all its servicing and liquidation processes, it can then ask the SBA to fulfill the guaranty. The SBA will send you a demand letter giving you 60 days to either pay, negotiate or submit a settlement offer. If you don’t act within those 60 days, they’ll refer the debt to the Treasury, who can intercept your tax refunds and Social Security checks, garnish your wages without a court order and add a 28% penalty.
Settlement on an SBA loan goes through the Offer in Compromise, and it isn’t automatic. The SBA will generally only accept a compromise offer if the offer represents what the debtor can actually afford to pay. The SBA won’t accept an offer if you have the ability to pay in full through a lump sum or installment payment plan. To qualify, the loan generally must be in liquidation status, you must not be in active bankruptcy (unless the court has approved the compromise), and you must have documentation proving that the full amount cannot be recovered. You can only formally apply once you receive the demand letter, although you can start collecting documents beforehand. COVID EIDL loans are not eligible. There is also a tax catch: if part of your loan was forgiven, the balance forgiven would constitute income to you, and generally must be reported on your federal income tax return. There are exceptions; for one, if at the time of forgiveness you were insolvent, then the income from the cancellation could be excluded from taxable income.
Another Option if Settlement Is Out of Reach Is Bankruptcy
Watch for avoidable mistakes. Just because you received the most calls doesn’t mean that is the lender you should pay first. Don’t treat the money you withhold from your employees’ paychecks for taxes as just more operating cash. If you don’t remit the taxes, you may be personally responsible for the Trust Fund Recovery Penalty, which will follow you after the business is closed and cannot be wiped out in bankruptcy. Also, don’t dip into your retirement funds that would have been protected in bankruptcy to pay debts that bankruptcy would have wiped out.
Another option if settlement is out of reach is bankruptcy. Under Chapter 7, the business’s non-exempt property is liquidated to pay the creditors. Chapter 11 bankruptcy is reorganization, which allows a business to keep operating while adjusting its debt structure. Many bankruptcy lawyers offer a free first consultation. Speak to an attorney who has experience dealing with business debt before making any major decisions, and consult with your accountant to determine what you can actually afford to pay. Settling after default is possible, but it is a negotiation, not a right. Reaching out early may leave you with more options.
