If you signed a personal guarantee on an SBA loan and the business can no longer pay, your assets could be on the line. A personal guarantee is a promise to personally repay a business loan. When you sign a personal guarantee, you take on legal responsibility for the loan’s repayment, even if the business fails. Even if your business has collateral for a loan, if you signed a personal guarantee, your personal assets could be used to pay back that loan. Most owners signed that guarantee without giving it much thought. There’s a fine print warning in there to be sure. But who reads that fine print? This article explains the details of the personal guarantee you signed, the process of an SBA loan default, and your options for resolving the issue.
So what counts as a default? The technical answer is that you are in default on an SBA loan if you fail to perform under your obligations contained in the loan agreement. Missing a payment, paying late, or making only a partial payment can each put you there. Take a simple example. David is owner of ABC, a deli that has been operating for three years. He bought it with an SBA loan, signing a personal guaranty for the loan. Now the deli is losing money and David can’t afford to make the payments on the loan, so he recently missed one. He hasn’t heard from the bank yet. He now thinks that he might be in default. It turns out that he is.
Demand Letter
Soon enough, the lender’s demand letter arrives. This is a letter telling you what you have failed to do and what they need you to do: written notice of the default and a demand for payment. Owners in distress often push the letter aside because they know they cannot pay. Ignoring it will not make it go away. If you ignore the demand letter, the lender will assume that you can’t or won’t pay. If you actively pursue negotiation with the lender, that indicates that you’re serious about attempting to satisfy the debt. They will likely respond. Being forthcoming about your situation gives you a chance to agree on a way to cure the default or make some other arrangement, and if you already know you cannot pay, this is the moment to bring in an attorney.
David’s first impulse is to do nothing and hope it goes away. Then he reconsiders. He knows he can’t pay, but if he tells the bank, he might be able to settle the debt somehow. He gets a lawyer and they write a letter to the lender. Here is what being forthcoming looks like in practice. Instead of denying the default or refusing to take responsibility, you choose to face the reality of your financial challenges. You reach out to the lender, communicate your willingness to work with them and resolve the issue. Your business may have run into hard times that have nothing to do with you, but the lender does not yet know that. You explain the reasons behind the default, acknowledging your role in the situation. By being upfront and honest, you build trust with the lender and show that you are committed to resolving the matter.
Offer in Compromise
If you can pay some of the debt but not all of it, there is another route: an offer in compromise. This is the lender’s willingness to accept a lesser amount than the total debt. If your offer is accepted, then you have settled the debt. Many of these settlements are paid in one lump sum, and that is how David’s story ends: David’s offer in compromise was accepted and he settled the debt in one payment. The lender certainly prefers to get all of the debt up front, but has some flexibility if he or she thinks there’s reason to think you might pay in the long run. If the owner can show they have the ability to pay, the lender may agree to installments. That way the borrower doesn’t have to come up with the money in a hurry. At minimum, you will have to show how you are going to pay, and provide a budget that shows that you can make those payments. Since the lender has the leverage in these negotiations, the borrower must demonstrate that they are willing and able to pay and, if there is a plan, that it’s a realistic one. Timing matters, so don’t wait to have the loan shipped to the Treasury Department to take action. Once your file has been escalated there, a negotiated settlement becomes a lot more difficult.
To see why the Treasury matters so much, remember that SBA loans are government-guaranteed. The bank was willing to take a chance on your business because the government agreed to repay a portion of the loan if you defaulted. When you signed that personal guarantee, you were saying, “If you do take a loss, I’ll cover it.” So when the payments stop and no deal is struck, the lender has taken the risk and lost. It gets to claim against the U.S. Treasury for a percentage of the default amount. For the borrower, that means the balance of the loan being turned over to the Treasury, which will likely garnish your bank accounts and collect on any wages or property. It can also repossess any assets you pledged to secure the loan, and the U.S. government can legally do this without a court order. This means that you may have to use your personal assets to repay the loan. In a short time you can go from a missed payment to a wiped-out bank account. Because government has the right to take over the file, you cannot afford to take the risk of letting it get escalated to the Treasury Department.
SBA Loan Bankruptcy
There is one tool that can stop all of this. It’s called bankruptcy. Bankruptcy can stop the collection of a government debt. Despite government’s extraordinary collection powers, filing bankruptcy is an attractive option to an owner because, in many cases, it will wipe out the personal liability for the loan. Once you file, neither the lender nor the government can seize your assets, garnish your wages or levy your bank account to make you repay. And once you receive a discharge, the lender can no longer pursue you for repayment of your SBA loan, and that’s one important result of filing bankruptcy. But keep in mind that even if you file bankruptcy and get the debt discharged, a lien on any asset you pledged as collateral is not wiped out. If you later sell that asset, the proceeds can still be used to repay the loan. Even so, filing SBA loan bankruptcy is a step you want to make sure is the right one. It’s not a decision to take lightly, and it is worth weighing against a settlement while one is still possible.
Here’s the bottom line: if you signed a personal guarantee, the bank can come after you. Understand what will happen and be proactive. If you are reading this with a demand letter sitting on your desk, the most important thing you can do is reach out for help now. You have options and you need to know what they are. If you cannot pay the debt, explain why. Even if your business has run into hard times, it may be possible to work out a settlement. Negotiating your way out of the problems here is about dealing with the lender before they write you off as a bad prospect. If you don’t face the reality of where you’re at, there’s no way you’ll fix it.
