What you need to know if you're considering an SBA loan default
Over the years I've had people call me and say, "I don't believe I gave a personal guarantee on this. I think it was non-recourse. I think they only took the guarantee from my business."
Sometimes they'll be confused and say, "I have a corporation or an LLC, so I didn't think it would have required a personal guarantee." Unfortunately, that’s incorrect, and they did not understand what they were signing. It's a shame that whoever was advising them at the time that they were signing these closing documents didn't fully explain they were personally liable.
In the 10 years that I've been doing this, I can count on one hand the number of people who didn't give unlimited guarantees. And those were situations where there were many partners who all guaranteed, say, 20% or something like that. The only other way that somebody wouldn't sign a personal guarantee – and it would be limited – would be if it were a spouse that had nothing to do with a business, and they signed a personal guarantee that was limited to their interest in their personal residence. That's required so that somebody can actually pledge their home as collateral. Essentially, it's the spouse acknowledging that the house is being pledged as collateral so they can't protest it later.
When you take an SBA loan, you will be giving a personal guarantee. What that means to you is that if the business defaults, the bank will look for you to pay back the loan out of personal assets. If you have equity in your home, they're going to look for you to borrow against it.
If you have cash savings, they're going to want it. If you had investments, they're going to want you to liquidate them. So if you don't fully understand what you're signing, you should stop and ask. You might ask an attorney. You could ask the banker, but keep in mind that they work for the bank. Whatever you do, make sure you find somebody who has your best interests at heart and who won’t let you sign anything until you fully understand it. Because otherwise when you default on your loan, it's going to fall on deaf ears when you claim that you don't remember signing it or that you didn't understand it.
Personal bankruptcy is not a perfect solution.
People will often say, "If the bank doesn't want to settle, forget them. I'm just going to file for bankruptcy." That’s great in theory, but not everybody qualifies for personal bankruptcy, and there's more than one type of personal bankruptcy. With chapter seven, yes, maybe you can wipe the slate clean and you won’t owe a thing. But if you have too many assets or you have too much income, you're going to have to do a different type of bankruptcy. Just to pay the bankruptcy attorneys can be expensive, since the process can drag on for months or even years. And then at the end of it, you may end up having a repayment plan anyway, so that’s not a perfect solution. The other thing that people don't realize is that if your home has been pledged as collateral and you file for personal bankruptcy and get a chapter seven, even if you're no longer personally liable, the lien on your home is still going to remain there.
This means that even if you do the personal bankruptcy, you're very likely going to have to go back to the bank and negotiate a release of the lien that’s on the property. I know this firsthand because the negotiation of lien releases for SBA-backed loans is a service that I offer, and I've done a number of them over the years.
There is a difference between a personal guarantee and a lien on your home.
These are not the same thing. A personal guarantee is all-encompassing. It doesn't take a lien on anything in particular. It's just saying, "All of your stuff – we're going to expect you to liquidate that and pay us." But it's not like the bank is specifically saying, "We’re going to take your couch or your motorcycle or your TV."
It's just a general pledge. Now, a lien on your home is a very specific pledge, and it means that they're actually going to put up your mortgage or a deed of trust on the property, which means that if you ever go to sell it and that lien sits there, the lien would need to be satisfied.
Just because you give a personal guarantee, it doesn't mean you're actually giving them a lien on your home. But be aware that when you sign a mortgage, that is much stronger because a personal bankruptcy is not going to get you out of it. That’s why it’s important that you understand the difference between a personal guarantee and a lien on your home.
To settle your SBA loan, your business does need to close.
Even though the SBA rules and the standard operating procedures do state that they can settle a business when it’s still open assuming you meet certain criteria, I can tell you that in practice, the SBA is unwilling to do that. I've had situations where we sent them an offer and said, "The business is open. We are willing to close it, pending approval of the settlement."
They rejected it out of hand every time; they wouldn't even consider the offer because the business was still open. So even if you find this language in the SOP, know that in practice, that’s now how things work. I've had people read me the policy and argue that I’m wrong when I tell them this. Believe me, I've read the policies, too. I understand them well. And I can tell you that I have not seen the SBA honor that policy. Maybe they did at some point, but in the last five to ten years, I have not seen it.
In addition to the business being closed, the assets need to be liquidated.
Your business doesn't have to be sold as a whole. You can do that if you have a buyer that will bring more value, and it will obviously improve the paydown on the loan. But it's not a requirement. So if you have a pizzeria and you can sell the equipment for $25,000, great. You can go ahead and do that. If you have a buyer who wants to buy the entire shop and take it over for $50,000, that's great, too. The important thing is that the assets get sold.
Keep in mind that there is a time component to the sale. Lenders are not going to give you forever to try to sell your business. At some point they're going to say, "Look, we need to liquidate, and it seems unlikely that you're ever going to sell it."
One other point to make regarding the liquidation of assets is that you must get your bank's permission. You cannot sell without telling your bank and then just pocket the money. I've seen that before. What happens? The bank can accuse you of fraudulent conveyance if you’ve sold their collateral. That’s going to cause a couple of problems for you. One, the bank can still go after that collateral.
That means your buyer is going to have the bank knocking at the door and saying, "We want our stuff back." The other problem is that this can potentially disqualify you for a settlement. If you fraudulently sell those assets, the bank isn’t going to lift a finger in terms of a settlement.
In sum, the bank isn’t going to negotiate until the liquidation of the assets is complete. And if you sell those assets and then spend the money on something else, it’ll completely blow up your chances of settling.
You need to prove financial hardship and lack of ability to pay.
The SBA does not negotiate for the sake of negotiating. In other words, if you owe them $25,000 and you clearly have $25,000, they're not going to negotiate with you. If you have the money you owe them, they want it. The only time that they're going to negotiate is if you show them that doing so is their best option, that taking a settlement is the best business decision that they can make. That’s why they ask for so much financial information from you: to verify whether or not you have the ability to pay.
They're going to look at tax returns, bank statements, and pay stubs. They're going to look at all of your assets and say, "Does this person have the ability to pay us?"
Additionally, to reach a settlement with the SBA, you need to prove financial hardship. That’s a pretty subjective concept, but essentially, they're looking at all of your financial documents and saying, "Does this look like somebody who's experiencing hardship?"
How do they do that? For one, they're going to look at your bank accounts. What kind of balances do you keep? Are you living paycheck to paycheck? They're also going to look at your credit report. Are you paying other creditors? Is the SBA the only one you're not paying? Because if the SBA is the only creditor you're not paying, maybe things aren't so bad, and you're just trying to get out of paying your loan.
All of which is to say that proving hardship can be very difficult. I've had people who had retirement accounts that were really well funded, with several hundreds of thousands of dollars. Those clients were working, they were making ends meet, and their credit was perfect. And even though we were able to prove they couldn't pay back their SBA loan, the SBA rejected their offer because they didn't think the clients met the criteria for financial hardship.
The OIC paperwork is more than just filling out some forms.
You have to be accurate, and you have to be pretty deliberate about what you're doing. In other words, it's not just taking a few minutes to write down the offer and saying, “Okay, I think I’ve done my best. Whatever happens, happens.” The SBA is looking for you to tell them a story, and the story needs to be accurate. They need the narrative that you give them to be backed up with all of your paperwork.
There are a number of sections on the personal financial statement that all tie together. If they aren’t completed accurately, all of a sudden you've got a disjointed story. In addition to that, you really want to provide evidence that backs up the information you give on your personal financial statement. So again, it's more than just jotting down your bank account balance and what you make and hoping for the best.
There really is a method to doing it, and it's not about misdirection. It's about clarity. It's about showing them in a very clear way exactly what your situation is. You give them the rationale for your offer, and they base their decision on whether or not your rationale makes sense. They make a decision by comparing the narrative that we're giving them to your personal financial statement and all of your supporting documents.
So understand that filling out those forms requires a certain level of accuracy and attention. Because there's a lot of money on the line.
The focus of our OIC narrative should not be on your misfortune.
Instead, it should be on why you can't pay. This is one of the biggest mistakes that I see people make when they come to me after they've tried to do their offer in compromise on their own. They've written several pages about all the terrible things that happened to them, why the business went bad, why they don't have any assets left. Everyone that screwed them, every bad thing that happened. The SBA does ask about the circumstances, but at the end of the day, they really don't care. Their job here is to collect as much as they can from you. So the focus of your narrative should be really explaining A) what you can afford, and B) why that's the most you can afford.
If you want to write a hardship letter, feel free. But you really want to make sure that they fully understand where your offer came from and why you believe that's the most you can afford. That's what they really care about. If you write a seven-page letter and those facts are buried somewhere in that letter, they're going to have a lot of trouble figuring out if your offer makes sense. My advice is to always be concise, and to focus on the right thing.
The SBA and your bank are not afraid of bankruptcy.
People threaten bankruptcy all the time. Almost every client that I have at least asks about bankruptcy. You need to know that the SBA and the bank don’t frighten easily. You can go to them with an unreasonable offer and say, "Well, if you don't take it, I'm just going to just file for bankruptcy, and then you'll get nothing." It doesn't scare them.
They won’t say, "Oh no – if they file for bankruptcy, we get nothing. Anything we get at this point is better." Not at all. Rather, they look at it and ask, "What do we get if we sue you, get a judgment, and go after your stuff?" For that reason, the threat of bankruptcy is not going to get you off the hook.
Which office you deal with at the SBA actually does matter.
The three most common SBA loans are 7a, 504, and Express Loans, and they all work differently. When you submit an offer in compromise, which office it goes to is going to depend on what type of loan you have.
And even though the SBA is one uniform organization, they do not treat offers in compromise the same in every office. Yes, they have the same rules, but they're interpreted differently. If you have a 7a loan, it's going to go to Herndon, Virginia. If you've got a 504 loan, it's going to go to Little Rock, Arkansas. On top of that, if you get a 60-day letter, depending on how much you owe, it's going to go to a different office. Understanding which office you're dealing with is actually a pretty big advantage. I've seen over the years that dealing with each one requires different strategies because each office reacts and communicates differently.
There is subjectivity in this process. The reason I mention this is that people always ask me, "What’s the bottom line here? How much do you think I can settle for?" And I usually tell them that it's a range, because the process is subjective. What one person sees as financial hardship. somebody else may say, "Eh, I think it's borderline."
The other thing is that people negotiate differently. I used to work for a lender, and if I thought somebody was making a very reasonable, supported offer, I would send it to the SBA. But I worked with people who wanted to nail clients for every single penny. That's two very different assessments – in one bank – of what constituted a reasonable offer.
If you settle, you will not get another SBA loan.
Here's an important distinction: the fact that you settle is not actually the thing that triggers you not getting an SBA loan; it's the fact that you didn't pay the loan back in full. That's important because some people want to base their decision about trying to settle on whether or not they'll get another SBA loan. If you do settle, you need to know that it’s the act of not paying back the SBA that gets you put on the CAIVRS list.
Regardless of whether or not you settle, if you don't pay the SBA back in full, you will be on that list.
An SBA offer in compromise may hurt your credit.
This is something that's changed over the years. Historically, most banks didn’t report personal guarantors to the credit bureaus, so if you signed a personal guarantee for your business, that generally would not appear on your credit report. That said, in the last couple of years I have seen settlements with the SBA that have been reported to the credit bureaus. In those circumstances, my clients went to the credit bureaus and challenged the addition, and the credit bureaus took it off.
But the reason that they were taken off was that the SBA forgot to give contact information. Lacking the ability to hear their side of the story, the credit bureau just removed the item. This means that it’s possible that at some point, the SBA will wise up, and personal guarantees will reliably show up on credit reports.
There may be tax consequences if you settle your SBA loan.
I'm not a tax guy. I'm not giving you tax advice. That's my disclaimer. But I do know that there are some exceptions to this point. Based on my understanding of the IRS rules for 1099 reporting, if you have a negative net worth at the time of the debt forgiveness, including the debt that's being forgiven, then it may not taxable.
The only other way that it may not be taxable would be if you have your business that's got huge losses. Let's say you paid $1 million for the business and then you liquidate for $10,000. I've had clients tell me, "My attorney said they're just going to basically write off any 1099 against the fact that I've got a $990,000 loss on this business asset that I purchased." I always tell people that they should walk into it with their eyes wide open, understanding what the possible tax consequences are.
I realize that everything I’ve covered above can be overwhelming, and it’s not surprising that people don’t fully understand every aspect of an SBA settlement. While it can be tempting to throw your hands up and walk away from the whole situation, or to bury your head in the sand, don’t do that. There’s too much money at stake. SBA loans can be settled for reasonable amounts, but you’ll have to play by the SBA’s rules if you hope to successfully navigate the SBA offer in compromise gauntlet.