If you took an Economic Injury Disaster Loan to keep your doors open during COVID and the payments are now more than the business can carry, you have probably asked yourself what would happen to that loan if you filed for bankruptcy. It’s a fair question, and most of the owners we talk to at Delancey Street have heard stories (or rumors) about what happens to EIDL loans during bankruptcy. The short answer: it depends. An EIDL can be discharged in bankruptcy, but what happens to yours turns mostly on how much you borrowed and whether you pledged collateral to get it.
Starting a business is hard; making it grow and stay profitable is even harder. According to the Bureau of Labor Statistics, about 20% of new businesses fail within their first two years, 45% within five, and 65% within ten. Many of these businesses succumb to forces beyond the owner’s control, such as the broader economy.
When the CARES Act went into effect on March 27, 2020, it created PPP and EIDL loans to help small business owners keep the doors open. But it also temporarily expanded access to Chapter 11 bankruptcy to more small businesses. Some owners used the loans to pay overhead and survive the crisis. For some, it was not enough.
Default on It
If you simply decide to do nothing on an EIDL, you aren’t going to be too safe. Default on it, and your lender can take legal action against you. They can also place a lien on your property or garnish your wages. So it is worth knowing what bankruptcy actually does to this loan. Here are six things.
1. It treats a federal loan like any other loan. A common misconception about SBA loans is that they stick with you the way a student loan debt does. The thinking is that a loan from a federal agency must be special. This is absolutely not true. It won’t and should not stop you from trying to discharge it. It turns out bankruptcy treats an EIDL loan like a normal bank loan. What the government thinks doesn’t matter. EIDL loans are eligible for discharge, contrary to some people’s misconceptions. A federal loan is just a loan.
2. It sorts the loan by whether you pledged collateral. The real question is whether it is unsecured or tied to an asset. In other words, is there something the creditor can potentially take if you don’t repay the loan? If so, bankruptcy treats the EIDL as a secured debt. If not, then it is an unsecured debt. The difference between a secured and unsecured debt impacts a number of other legal and practical factors.
3. It can wipe out a small EIDL. If your EIDL was under $25,000, no collateral was required, so it is unsecured. In that case bankruptcy will generally extinguish it. In practice, you don’t have to argue what property the loan is secured against, because there isn’t anything. If all goes well, the loan is discharged at the end of the case. The borrower is not on the hook for this EIDL anymore. Note: “generally” because as every bankruptcy lawyer knows, each case is different. There can be special circumstances.
4. It puts that small EIDL in the same line as everything else. It is a loan like any other. It goes into the pool of unsecured debts together with all of the other unsecured debt holders. They are all treated equal. The EIDL gets no priority over the rest.
The same goes for PPP. PPP loans were intended to be forgiven, but if not forgiven, if you file before forgiveness, they are dischargeable. Both your business and your personal bankruptcy. They too fall in with the pool of unsecured debts. They are not given a special status like student loans are. If Congress had wanted PPP loans to survive bankruptcy, it arguably would have written that into the law that created them. But there is no such language in the CARES Act, so you can assume they are dischargeable. Keep in mind there can be complications if the SBA or the lender discovers errors in your original application, making it non-dischargeable, but that’s pretty rare.
5. It leaves the lien on a secured EIDL in place. If you take out an EIDL of $25,000 or more you need collateral for it, and that changes things. The debt is secured now, in the eyes of bankruptcy. Instead of going in the pool of unsecured debts, you’ll have to address that lien separately. This means you can’t count on that being discharged. If the company or the owner pledged assets to secure the loan, that lien will remain in place. The collateral has not gone away. For those loans, the government may seize your asset to satisfy your debt, rather than discharge the debt.
6. A personal guaranty makes it more complicated. If your EIDL was $200,000 or more, a personal guaranty had to accompany the application. That means that in addition to the business, you have personally agreed to repay the EIDL debt. If you have a personal guaranty, then filing bankruptcy can complicate your ability to discharge your EIDL debt.
Bankruptcy Might Not Make Sense for Your Situation
None of this means bankruptcy is the right move for every owner with an EIDL. Some owners can earn a discharge by filing bankruptcy. Some can’t. Sometimes bankruptcy might not make sense for your situation. It is nothing to take lightly. You should also note these explanations are on a high level. Every situation is different, and the specifics of how an EIDL appears on your situation may vary.
At Delancey Street we are a business debt settlement company, not a law firm, so when bankruptcy looks like the right path we do refer our customers to a bankruptcy lawyer for proper legal advice. A bankruptcy attorney can address each business’s specific situation, help weigh options, and analyze your best move. When it is not, we negotiate with lenders for business owners, SBA loans included. We are here to help you negotiate a debt settlement with the lender, and that may be a better option for you. It’s just not a good idea to simply ignore the loan.
