Personal Guarantee
Most SBA loans come with a personal guarantee – that means that if you cannot make the payments, they can come after your personal assets. The SBA can even take the borrower’s home if that home was used as collateral on the loan. As a result of the personal guarantee, you are at risk of having your personal bank accounts, home equity pledged as collateral, and even any wages from any job you have garnished. Furthermore, failure of the business does not free you from the guarantee. The good news is that you may be able to settle the loan and maybe even get part of it forgiven before it gets to that point.
Many owners take comfort in the SBA’s own guaranty on the loan, but that guaranty protects the lender, not you. The guaranty becomes significant only after the borrower defaults on the loan. However, the guaranty does not lessen the borrower’s obligations. The borrower is liable for the entire loan amount, not just for the portion of the loan that is not guaranteed by the SBA.
If you own 20% or more of a small business, the Small Business Administration requires you to provide a personal guarantee on a business loan. Sometimes, businesses have multiple large owners. In such cases, each owner is responsible for the full loan balance. And you might need to negotiate with the SBA separately, depending on your ability to pay. They won’t split it with you.
An Offer in Compromise
The formal route to a settlement has a name. It’s called an offer in compromise. The borrower pays the lender less than the balance due, and the difference is forgiven. And it’s not automatic. You can’t use this program as a short term cash flow solution and you won’t qualify if you are current on your loans or can pay off your loans in full. There is no right to compromise a loan.
To qualify, you must meet several requirements. The lender’s loan must already be in liquidation status, meaning you can’t still be making payments on it. You must not be in active bankruptcy. And the SBA must determine that it can’t fully recover the amount, for example because you can’t repay the loan in a reasonable period of time, or because the cost of collecting would exceed the benefit, or because repayment would be a hardship to you because of illness. There can’t have been any fraud involved. In practical terms, your business will usually have to have closed.
Timing matters more than most guarantors realize. Your lender administers the loan until it concludes that the debt cannot be collected. Then the lender notifies the SBA. The SBA will send you a demand letter. You have 60 days to respond. That’s when you file your offer. You can request an extension if you need more time. But you must ask for it in writing before the 60-day window runs out. The process will likely take at least four to eight months.
If the demand letter is ignored or the offer is rejected, the debt will be transferred to the Treasury. One former SBA lender executive says Treasury adds a 28% penalty to the balance due, and demands at least 50% of the amount owed. Treasury can take any federal tax refunds, and Social Security benefits, that the owner is entitled to receive. And Treasury can garnish up to 15% of the disposable pay from any employer without going to court. And unlike many private debts, this is not something you can simply wait out.
So how much should you offer? The SBA will weigh your offer against the amount it could collect if it enforced its collection. This means it will look at the liquidation value of any collateral, the market value of non-exempt assets (such as home equity exceeding the homestead exemption, vehicles, investment accounts and cash); wages through wage garnishment; and your future earning potential, considering your age, health and employability. The SBA will also subtract any exemptions, legal costs, risk of loss in a court case and the fact that any money the SBA collects years from now is worth less.
That is why low-ball offers typically get rejected. The SBA will generally not consider an offer under $5,000, except in a situation where the borrower cannot pay the minimum, for documented hardship reasons. For example, if the borrower has a solid job and $100,000 of home equity above the homestead exemption, the SBA knows it can garnish wages and eventually do a forced sale, so don’t propose a $5,000 offer.
Your payments to the SBA can be structured in one of two ways: a lump sum within 90 days of acceptance (which is preferred by SBA because it means the agency gets the money quickly and closes the file), or over the course of up to 36 months in installments (which is harder to be approved for). Be aware that, if you’re approved for installments, missing an installment means you owe the full original debt minus whatever you’ve paid already. (Hint: sometimes borrowing from family to get a lump-sum payment is a good idea.)
The next part of the application process is the paperwork. You’ll need a written offer on SBA Form 1150 indicating the source of the funds and detailing any special circumstances, such as illness. You’ll also need a personal financial statement on SBA Form 770, your two-year personal tax returns, and IRS Form 4506-C or 8821. If the business is still operating, you’ll also have to provide the business’s two-year tax returns and end-of-year statements. Finally, the lender will run a credit check on you. Missing documents give the SBA an easy reason to say no, and so do recent asset transfers that look like you are hiding money.
A settlement also has consequences of its own. Normally, forgiven debt is considered taxable income and you should expect to receive a 1099-C. There are exceptions, such as if you were insolvent at the time of forgiveness. Speak to your accountant. (Debt forgiven in a bankruptcy is generally not taxed.) If you default on an SBA loan, you will be added to the CAIVRS database. You’ll typically be blocked from getting a new federal loan, such as a new mortgage that uses an FHA guarantee.
If you are struggling but have not yet defaulted on your SBA loan, call your lender and ask for help as soon as possible. If you haven’t defaulted on your loan, you might be eligible for a forbearance or deferment, which can buy you time, but neither a forbearance nor a deferment reduces the amount you owe. Don’t try to sell business assets without the lender’s permission because the SBA has a lien against the assets and it can sink a settlement. The earlier you act, the more options you have. And before you commit to any settlement, it is worth asking a bankruptcy attorney whether bankruptcy would serve you better.
