Owners who are in arrears on an SBA loan frequently ask how filing for bankruptcy would affect their situation. An SBA loan is a loan from the Small Business Administration. These loans are for individuals who want to start a new business, or those who already have a business and just want to keep it running. Owners may choose to finance their business through an SBA loan because it may be hard for a small business owner to obtain financing through other means, and the terms on the loan are sometimes better than they could receive on their own. At Delancey Street, we negotiate SBA loans in addition to merchant cash advances and other business-related debts, so we hear this question quite often. The answer largely depends on two factors: whether the loan is secured by collateral and whether the owner signed a personal guarantee. Here are seven things a bankruptcy does to an SBA loan, and what each one means for you.
Discharged by Bankruptcy
First, it usually wipes the loan out. SBA loans, or small business loans, are, in most cases, discharged by bankruptcy. That means that after bankruptcy the owner does not owe anything for the loan; it is treated as any other unsecured debt.
Second, it may not touch a secured loan. There’s a particular case where an SBA loan won’t be wiped out by bankruptcy: the loan is secured by collateral in the debtor’s name. If that is true, then depending on the SBA loan’s position relative to other secured claims, the loan can survive the bankruptcy.
Third, it reaches your personal guarantee. In almost every instance, the person owning the business will have to sign a personal guarantee on a SBA loan. A personal guarantee is where you commit to paying a debt yourself in the event that the business is unable to do so. In other words, if the business runs out of money or goes under, you take over the debt personally. If the business defaults, the lender is entitled to not only the business assets but also the personal assets of the owner. The way to tell if you have guaranteed the loan is that you signed the loan documents for the business (once) and in your own name (a second time) in your capacity as ‘Individual’. Don’t feel bad about signing it. Most lenders will not loan the money without that personal guarantee. The good news is that bankruptcy deals with the guarantee as well. For consumers, there are two chapters under the bankruptcy law - Chapter 7 and Chapter 13. These chapters handle your personal debts and even your personal responsibility for business debts. The plan is to wipe those debts clean for you personally.
Fourth, it handles your side of the debt, while dissolving the company handles the business side. Most of the time, the owner will dissolve the business with the Secretary of State at the same time they file for bankruptcy. Dissolving the business takes care of the company’s part of the debt, and bankruptcy takes care of the personal part.
Keep the Debt Associated with the Property
Fifth, it makes you choose between the collateral and the debt. In bankruptcy, secured debt (like a mortgage, car loan or even an SBA loan) is treated differently than unsecured debt. If you want to keep the property, you must keep the debt associated with the property. For example, if you own a car that is worth $14,000, but have a loan against the car of $13,000, you have the option to surrender the car and debt to the lender, or you can keep the car after bankruptcy and continue making payments on the loan.
Sixth, it usually leaves a loan secured by real estate in place. If your home is worth $450,000 and has a mortgage of $300,000, the mortgage is fully secured because the balance does not exceed the property’s value. An SBA loan, for example, in the amount of $50,000 may also be secured by the same house. The SBA loan is in second position behind the mortgage lender, but it is still fully secured. The important thing is where the SBA lender falls in line with other secured creditors. If it’s in second place behind a mortgage lender, it’s not automatically an unsecured loan. If the property is worth more than the first lender’s balance plus the SBA balance, then both loans are fully secured, and the SBA loan will survive the bankruptcy.
Seventh, it changes the math on what is left. An SBA loan that is secured does not go away during bankruptcy. It stays with you, and you have to keep paying it afterward. But most people find that by discharging all of their unsecured debt, they can manage their monthly secured payments. If you just look at the math, having your other debts wiped out by a bankruptcy feels a lot like getting a raise.
Which of Your Debts Are Secured
Before you make any decision, you need to know which of your debts are secured and which are not, and whether you can actually afford the remaining payments on the secured ones. That’s a calculation best done with a bankruptcy lawyer. We are not a law firm, so when bankruptcy makes sense we hand you off to a trusted independent bankruptcy attorney, such as Subchapter V counsel. If bankruptcy is not the right path, our senior advisors step in and negotiate down with lenders, including SBA lenders, to less than the full amount owed. Your first consultation is free and confidential, and if there is a less expensive route we will tell you on the first call.
