SBA Loan Default: Does this mean Bankruptcy for the Business Owner?

SBA Loan Default: Does this mean Bankruptcy for the Business Owner?

I frequently am asked this question from concerned business owners: “If I default on my SBA loan, and the bank calls the loan, do I have to declare bankruptcy?”

The answer is a resounding “NO!”

Bankruptcy is only necessary in certain situations.  Many, if not most, situations of default (and the resulting workout) can be handled more effectively, for lower costs and better results for you, the business owner, outside of bankruptcy court.

The key is that you have to a clear understanding of what the secured creditors would obtain if the company were to declare chapter 7 (liquidation), and then figure out what the secured creditors would get from the borrower, if he/she were to declare personal chapter 7.

When a business fails, the bank must first liquidate the business assets.  They typically get pennies on the dollar at the end of this process.  However, the company loan does not go away, but merely become personal debt on the original borrower by virtue of the borrower’s personal guarantee (PG).  But even if the borrower’s PG has little or no value, the borrower must deal with the debt or it can snowball into an unforgiving issue that can lead to wage garnishment, judgments, lawsuits from the Department of Justice, and other unpleasant outcomes.  Most people when faced with this situation think the only solution is to declare bankruptcy.  However, the SBA actually has a procedure for settling defaulted loans called the Offer In Compromise.

The Offer in Compromise allows the borrower to make an offer to the SBA to settle their outstanding debt.  This offer can either be in the form of a one time payment, or a monthly payment plan.

The Offer in Compromise does NOT require the borrower to declare bankruptcy.

In addition, the settling an SBA debt with an Offer In Compromise has NO effect on the borrowers credit score – so it is possible to huge debts for pennies on the dollar with NO NEGATIVE IMPACT ON YOUR CREDIT SCORE.

The key to success in making an Offer In Compromise is understanding the process, understanding your bank, and presenting the necessary information in exactly the manner that your bank and the SBA require.