You borrowed money through the SBA to keep your business alive, and now the business is in trouble anyway. Sales are down and you have not been able to make your loan payments. Bankruptcy seems like the only option. What does this mean for your SBA loan debt? Can you get rid of your SBA loan with bankruptcy?
You may be looking for a bright line rule and believe that all SBA loans can be discharged or an absolute belief that all SBA loans cannot be discharged. Either assumption is very likely incorrect. In most cases an SBA loan is discharged in bankruptcy, just like other unsecured debt. The exception is a loan secured by your collateral, which may survive the filing depending on where it stands among your other secured creditors.
An SBA Loan
An SBA loan is a loan made by the Small Business Administration (SBA) to a small business, meant to help an owner open the doors or keep them open. Owners usually end up with one for one of two reasons.
- They can’t get a loan from a traditional bank.
- They can get a loan from a traditional bank, but the SBA loan is a better option.
Nearly every SBA borrower is also required to sign a personal guarantee. If you signed the loan documents once for the business and a second time as an “Individual,” you almost certainly signed a personal guarantee. A personal guarantee makes the guarantor responsible for repaying the debt on behalf of the business. Theoretically, all your personal assets could be at risk for repayment of the loan. A loan might be in your business’s name, but the guarantee assures that your personal credit is still on the line, so you can’t just close the business and walk away. If you did sign one, don’t feel bad. Practically every lender requires a personal guarantee on these loans and it’s in their best interest to require it because it protects them.
Personal Guarantees Get Wiped Clean
So can bankruptcy get you out from under a personal guarantee? It can. Business owners who file personally almost always use Chapter 7 or Chapter 13, and with those types of bankruptcy, personal guarantees get wiped clean. Both chapters cover your personal debts along with your personal obligation on business debt, and the goal in either one is a “discharge” - the extinguishment of your obligation to repay the debt. So if you guaranteed a bank debt on a business, for instance, a bankruptcy will typically extinguish your personal obligation to repay. That means the lender can’t collect on it against you, even if it seems like the debt should still be payable.
That takes care of you personally. But what about the business, which signed the loan too? The business is responsible for the loan, and you as an individual are responsible for the loan. The bankruptcy deals with your half. For the other, the owner will usually dissolve the company with the Secretary of State around the time the bankruptcy is filed. Once that happens, the business that signed the note is gone and can’t be held responsible.
Secured Debt
But there is a catch, if you had secured debt and used collateral to secure the loans, the lender may be able to hold on to the collateral. Whether you can retain the property will depend on what class the lender is in among the secured creditors in your case. Secured debt is debt that is tied to the value of an asset you own. The secured creditor has the right to take the asset if you default on the loan. Bankruptcy treats it the same way whether it’s a mortgage, a car loan or an SBA loan: keep the property, keep the debt. Say you own a car worth $14,000 and still owe $13,000 on it. If you don’t want the car, you can surrender it to the lender, release the debt, and walk away from it. If you do want to keep the car, you have to keep paying the debt. If you don’t make the payments, the bank will be within its rights to repossess the vehicle.
Most SBA loans are secured by real estate, and often that means your house. Suppose your home is worth $450,000 on the market and you owe $300,000 on the mortgage. Since the balance is under the home’s value, the mortgage is fully secured, and because your home is secured by a first mortgage, which has priority over any subsequent liens, you own only $150,000 (450,000 - 300,000) of equity in your home. Now add an SBA loan with a $50,000 balance, also secured by the house. In that setup the mortgage holder is your first priority creditor and the SBA is second in line. Second place still leaves the SBA lender well covered, since its $50,000 fits inside the $150,000 of equity, so the SBA loan is fully secured too.
So where does that leave you once the case is over? If your SBA loan was unsecured and got discharged, you have a fresh start and aren’t on the hook for the SBA debt anymore. A secured SBA loan is different. It survives the bankruptcy, and you are still obligated to make the payments afterward. In cases of secured debt, you still own the property and the lender holds a lien on it. The lien is still valid. If you do not pay the debt, the lender can put the property into foreclosure. Remember, to keep the property you have to keep the debt. If you want to hang on to the home, you will still need to pay both the mortgage and the SBA loan.
That may sound grim, but think about what the rest of the bankruptcy did for you. Once the other unsecured debts are gone, your expenses go down. You are free of the unsecured debt and should have more disposable income. Most people find they can handle the monthly payments on their secured debt after that. In plain numbers, the discharge works a lot like giving yourself a raise.
So, can you erase your SBA loan debt through bankruptcy? Yes, in most cases, you can, at least as to your personal liability. Even if you signed a personal guarantee, it can be discharged in a bankruptcy. If the loan is not secured, you are in pretty good shape. If the loan is secured, be aware that it may not be extinguished with the rest of your unsecured debt. Make sure you know who your creditors are and who is holding a secured loan. Many SBA loans are backed by real estate. Check the collateral list to see if you have anything secured. If you do, you will still have to make those payments after bankruptcy. Make sure you have all your documents in order. Review those docs to see if the SBA is on your list of secured creditors. If it is, the loan may not be erased. Working with an attorney who understands your situation and can do the numbers can help you sort it out.
