Congress created PPP under the CARES Act. Using the money correctly brings full or partial forgiveness. But not using the money as intended leaves the borrower to repay what the SBA does not forgive. The SBA runs the program and guarantees any unforgiven balance.
It administers the program under its existing Section 7(a) loan program, through which approved lenders make loans directly to borrowers. The SBA backs the loans with guarantees against a portion or all of the risk of default. When lenders make loans following the SBA’s guidelines, it pays the guarantees after loss.
Moreover, a traditional lender would require plenty of collateral and make owners sign a personal guarantee. There’s no collateral or personal guaranty for owners on the PPP loan. Even partial forgiveness is common with the PPP, but it’s not guaranteed. The bank does have a claim for any unforgiven amount on the PPP loan, but it’s just an unsecured general obligation of the business.
The lender bears some responsibility, even for a Paycheck Protection Program loan. On a secured 7(a) loan, the lender must use diligent, commercially reasonable efforts to sell any available collateral. And must take reasonable efforts to collect from guarantors. With the PPP, there is neither. Collection on a PPP loan follows the same process but without the collateral and personal guarantee steps. That means the lender still has to pursue the borrower with diligent collection efforts.
Diligent Collection
In practice, the lender must provide diligent, commercially reasonable efforts to collect from the borrower before SBA will pay a guaranty or allow a charge-off. That includes the following efforts, but not necessarily in this order:
First, the lender should try to work with the borrower to cure the missed payments. That’s much the same as with any comparable unsecured loan.
Before a lender decides to sue a borrower, it has to figure out whether it’s actually worth the time and money. Before it runs up legal bills, the lender should see what’s out there to grab.
SBA rules don’t usually require a lender to conduct a site visit if the loan’s not secured by business assets. The loan amount might still merit a visit. Loan size and what the lender knows about the borrower will impact the decision.
Asset searches really matter at this stage. They tell if a judgment is worth chasing.
Doing diligent collection also means knowing whether the debtor transferred things to avoid payment. By looking at recent transfers and sales below market value, an asset search might spot a possible fraudulent conveyance. Those have varying rules but some may trigger the prior transactions to be undone and recovered.
Put the Loan in Litigation Status
If cure efforts fail and the loan stays unpaid for 60 days straight, it’s time for the lender to accelerate the balance due, send a demand letter, and tell the SBA to put the loan in “litigation status.”
SBA requires a litigation plan if the lender seeks to put the loan in litigation status. Doing that does not mean the lender must actually sue. The plan sets out the likely steps the lender might follow. Not every set of facts is ripe for litigation. SBA gives lenders a litigation plan template on its website.
The first item in a lender’s litigation plan is the results of any site visit, or the reasons why a visit did not take place.
For a Paycheck Protection Program loan, the most obvious reason for skipping the visit is that the bank has no security interest. The bank would also be more likely to skip it if its asset searches turned up nothing collectible.
The next item on the lender’s litigation plan says how likely the borrower is to work things out, or settle, or maybe repay through a loan modification.
That question is about your business’s ability to pay. It’s really asking how likely it is that you and the lender can set up a modified loan you’ll pay. And how likely the lender might just make a deal with you.
The lender tells the SBA how much it expects to recover from unencumbered business assets. And its estimate has to be reliable.
That’s where the site visit and asset search back up the estimate. They tell what there really is to recover.
The lender’s also going to disclose if it has other loans to the borrower. The SBA wants to know so the lender doesn’t play favorites.
The lender cannot favor the other loans over the SBA loan. That’s to prevent the lender from paying itself instead of SBA first.
The lender is also going to want to reach an agreement with the SBA to split up the money that gets recovered.
Plans for routine, uncontested suits, foreclosures or bankruptcies expected to cost under $10,000 in fees don’t need SBA approval. Every other plan does.
Liquidation and Charge-off
Before a bank asks SBA to charge off its PPP loan, it has to exhaust its other efforts or convince SBA it should charge off anyway. That can happen when costs of collecting get to be more than they bring in, or if the borrower goes missing or flat broke, or if the debt simply is no longer collectible under the law.
First, the bank has to show its exhausted every reasonable way to recover. On paper, that includes accepting voluntary payment, negotiating a compromise, selling collateral, and forced collection.
Second, a bank can show it’s clear that more collection efforts would likely cost the bank more than they bring in.
And third, only borrowers who can’t be found or have absolutely no money left remain, or the law no longer allows the bank to collect the debt.
The SBA posts a Charge-off Checklist on its website for lenders.
The lender can file a so-called Guaranty Purchase Package with the SBA to get the guarantee paid out, before finishing its liquidation and charge-off. The SBA recommends that the bank finish liquidating the loan before it submits the purchase package. The SBA has a template Guaranty Purchase Package on its website.
Some lenders and their lawyers need a reminder that they represent the SBA, too, as long as it is still backing the note. And the lender’s duty lasts until the SBA pays the guarantee and takes over the loan. Until then, the lender must act in the SBA’s interest in proceedings like bankruptcies.
A 100% SBA guarantee isn’t a free pass. The SBA expects a lender to do the real work required of a prudent lender, whether for a forgivable PPP loan or any other 7(a) loan. The most important difference is that the rules matter only to the portion of a PPP loan the SBA does not forgive.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
