Bankruptcy: What Happens to SBA, PPP, and EIDL Loans?
In recent trends, the level of business and corporate bankruptcies has risen dramatically. As more and more businesses are considering bankruptcy, one of the most critical questions is what happens with SBA (Small business loans), PPP, and EIDL loans when filing for bankruptcy.
During the last several years, the federal government has been approving many businesses for SBA, PPP, and EIDL loans to help business owners stay in business during the COVID-19 years.
Although some of those loans went to certain individuals who tried to defraud the government, these loans helped more businesses stay afloat.
For many businesses, these loans were simply a short-term band-aid keeping the business open until the money ran out. Now that the money is gone and business has not yet resumed to pre-COVID levels, you might be considering filing for bankruptcy to get rid of your SBA debt. Let’s examine this issue.
Small Business Loan Bankruptcy
Are SBA, PPP, and EIDL loans dischargeable in bankruptcy? SBA, PPP, and EIDL loans are all dischargeable in bankruptcy. If a business owner files for Chapter 7 liquidation bankruptcy, these loans can all be discharged.
In Chapter 11 business bankruptcy or Chapter 13 personal reorganization bankruptcy, you may be asked to pay a percentage of the debt through your reorganization plan, which depends largely on what your income and expense schedules dictate you can afford to pay. However, these loans are all considered to be dischargeable debt in bankruptcy.
SBA Rules on Bankruptcy
The SBA has specific rules that determine how their loans are affected, and navigating these rules is crucial to making informed decisions. Let’s explore the SBA’s stance on bankruptcy and the key considerations you need to keep in mind.
SBA Loan Types
The most common ones are the Paycheck Protection Program (PPP) loans, Economic Injury Disaster Loans (EIDL), and regular SBA loans. Each loan type may have slightly different implications in bankruptcy.
Dischargeability of SBA Loans
SBA loans are generally considered dischargeable in bankruptcy, meaning they can be eliminated if certain conditions are met. This applies to both personal and business bankruptcies.
Chapter 7 Liquidation Bankruptcy
In a Chapter 7 bankruptcy, a business’s assets are sold to pay off debts. If you have an SBA loan, it can be discharged along with other unsecured debts. However, if you pledged collateral for the loan, like your business equipment or property, the SBA might use those assets to repay the loan before other creditors.
Chapter 11 and Chapter 13 Bankruptcies
For businesses filing under Chapter 11 or individuals under Chapter 13, SBA loans may still be dischargeable, but the process is different. The court might decide how much of the debt you need to repay based on your financial situation.
Secured Loans and Collateral
If you provided collateral for an SBA loan, such as your business assets or personal property, bankruptcy may impact how that collateral is treated. In Chapter 7, it could be used to repay the loan, but in Chapter 11 or 13, you might be able to restructure the debt while keeping your assets.
Misused Loan Proceeds
The government monitors how SBA loan funds are used. If you misused the funds or didn’t follow the loan terms, bankruptcy might not discharge the debt related to those funds. The government could challenge the discharge of such debts in court.
If you personally guaranteed the loan, even if your business files for bankruptcy, you might still be responsible for repaying the debt with your personal assets.
The government scrutinizes how loan proceeds were used. If you’re filing for bankruptcy, you might need to prove that you used the funds properly for allowed purposes.
What If My SBA, PPP, Or EIDL Loan Was Secured?
For many businesses that took larger loans out during the COVID period, the SBA may have required a security agreement against the business assets for collateral on the loan. In some
cases, the SBA may have required personal assets such as your home as collateral for the loan.
If the business is filing a liquidation bankruptcy under Chapter 7, the assets sold or liquidated would go toward paying off the SBA loan before other creditors would see anything. Remember that in a Chapter 7 business bankruptcy, there is no discharge.
In liquidation bankruptcy, your business is liquidating all assets. The money gathered from the asset liquidation is used to pay off creditors. Once that process is complete, the case ends and the business winds down.
If you have used personal assets such as your home as collateral on the loan, filing for bankruptcy does not remove the lien from your home. Your personal bankruptcy will discharge the debt to you but a consensual lien on your home will remain intact.
What if I Personally Guaranteed the Loan?
A personal guarantee is often required for any business loan or credit application. A personal guarantee means that you have pledged to pay the loan from personal assets or income even if the business is unsuccessful.
This means that if your business closes, you personally are responsible for the debt. If you file a business bankruptcy under any chapter, it does not absolve your personal responsibility for the debt.
This also works the same way if you file a personal Chapter 7 or 13 bankruptcy, but intend on keeping your business open. A personal bankruptcy under any chapter may discharge the debt as to your personal affairs, but your business is still subject to the debt and creditors will require payment from the business.
The Government is Reviewing These Loans in Bankruptcy
A very important question we need to address in any bankruptcy is how the loan proceeds were used in your business. The government is reviewing many business owners’ use of these proceeds to make sure the proceeds were used in accordance with the government’s regulations.
When filling out an application for these types of loans, the business must attest to the use of the loan proceeds for payroll, fixed debts, accounts payable, and other regular business expenses or working capital.
The government is regularly checking into business and personal bankruptcy filers who are attempting to discharge these loans as to how these loan proceeds were used. It may become necessary to prove how the business used these loan proceeds in court.
What Happens If My Business Misused Or Misapplied These Loan Proceeds?
If you have not yet filed for bankruptcy, the government can sue you for repayment of the loan proceeds, especially in PPP or EIDL loans that were not required to be repaid.
If you have filed for bankruptcy under any chapter, the government can request documentation through an examination called a Bankruptcy Rule 2004 Examination. In these types of cases, the government can call you into court to produce documents and proof of how these funds were used in your business.
If you are unable to prove how the funds were used, you may be subject to a lawsuit in bankruptcy court objecting to your discharge of such loans. The government will have to prove that your use of these loan proceeds was due to false pretenses, false representation, or even fraud.
If the debt is found to be non-dischargeable due to these circumstances under the law, then you would still owe the debt even though you filed for bankruptcy and received a discharge as to other types of debt.
This article is not to say that a determination will be made in every case. The more significant the amount of your SBA, PPP, or EIDL will factor into the amount of review the government conducts.
Also, if you have a personal guarantee, the government may overlook your loans unless you are filing both personal and business bankruptcy. However, anyone who is considering a business bankruptcy should be concerned about any SBA, PPP, or EIDL loans and how these proceeds were used.
If you are confident that your use of these loan proceeds was all in good faith and under the guidelines of the SBA, then your case will likely go through without an issue from the SBA or the federal government.
Also, if there is a review and a threat of non-discharge ability action, you can attempt to settle with the government rather than go to trial. For many people, going into bankruptcy means that funds are low or limited and you may not have a lot of money to pay for legal fees and court costs associated with a trial. In these cases, settlement may be a better option.
In any event, filing for bankruptcy carries inherent risks. The government is looking for blatant fraud in the use of SBA, PPP, and EIDL loans. The federal government is looking for ways to recoup funds from individuals or businesses who have fraudulently obtained funds from the government, and misused or misapplied funds for uses other than what was allowable.
Talk to a lawyer before entering into any bankruptcy filing. Call us today if you are considering filing for bankruptcy. We can offer you a free consultation and affordable payment plans for your legal fees.
Frequently asked questions
What happens to my EIDL loan if I die?
If you were to pass away, the EIDL loan will remain secured to your business and any business assets you pledged as collateral. If someone such as an heir will be continuing with the business, then the loan will remain due and will need to be repaid.
If your heirs will not be continuing with the business, then the proceeds from the sale of any business assets would need to be paid to the loan.
Will EILD loans be forgiven?
Can an Eidl loan be forgiven? EIDL loan forgiveness depends on the amount of the EIDL loan and the contract signed at the time you took out the loan. Some EIDL loans were considered forgivable, and others were not. You would need to review the contract you signed when you took out the loan. If you or your business files for bankruptcy, then the loan would be able to be discharged or forgiven in your bankruptcy.
Am I personally liable for my EIDL loan?
This depends again on the contract you signed. The SBA may have required you to sign a personal guarantee or it may have required you to pledge property as collateral for the loan. If this is the case, then you are personally liable for the loan even if your business closes.
Also, if you pledged collateral for the loan such as business or personal property, then the lien associated with the collateral would remain in place until the loan is paid in full. You could remove the lien by filing for bankruptcy under certain circumstances, which I recommend contacting a bankruptcy lawyer for advice on your loan and your situation.
What happens to an SBA loan if the business closes down?
If you close down your business, then you are required under the law to complete a winding
down of the business. Winding down your business means that you are selling all tangible assets and liquidating all intellectual property or assets, then using the money received to pay off the debt owed by the business.
The last step is to formally close the business through the state procedures as set forth in your area. This may be a more complicated process depending on the size and structure of your business.
If the SBA loan is not paid off through the sale or liquidation of business assets, then the remaining amount would be uncollectable unless you personally guaranteed the debt or pledged collateral against the debt. In that case, you personally would remain liable for whatever balance is left on the loan. You could file for a personal or business bankruptcy for help with discharging any remaining debt including any SBA, PPP, or EIDL loans
that remain in the business.