Defaulted SBA Loans: How SBA Loans Differ from other Forms of Credit when it comes to Collection, Personal Guarantees and Discharging SBA Loans in Bankruptcy

Often when a small business obtains bank financing to start-up or expand operations, it does so with a loan that is guaranteed by the federal Small Business Administration (SBA). SBA financing is typically administered through a major bank and is guaranteed by the U.S. Small Business Association, an arrangement that benefits small business owners who may not otherwise be able to obtain personal financing to expand their enterprise. Unlike other forms of business credit such as credit cards and vendor liabilities, the SBA loan will survive the failure of a small business and remain a personal liability of the business’s principal under a principal’s personal guarantee.

SBA loans differ from most other forms of credit in several respects when it comes to the SBA’s recourse under a defaulted SBA loan. First, any default in the payment of the SBA loan may quickly lead to an administrative wage garnishment of the guarantor’s income. Unlike other unpaid creditors, the SBA is authorized under federal statute to immediately order garnishment of the guarantor’s net wages—usually 25%—to satisfy the delinquent SBA loan. In contrast, most other creditors must first initiate litigation and obtain a judgment in a court of law before wages can be garnished, a process which takes several months at a minimum. This means that the SBA can more readily and rapidly force the collection of unpaid SBA loans via wage garnishment of the principal.

Second, the SBA loan may be secured by a lien on the principal’s personal assets including on one’s homestead. In this manner, the SBA loan operates as a mortgage on the principal’s residence and defaulted SBA loans could lead to home foreclosure. While foreclosure in Minnesota entails strict notice requirements and the owner’s opportunity to cure prior to a sheriff’s sale, a completed foreclosure can cause personal upheaval for the owner if they lose their home in addition to the loss of their small business. For this reason, foreclosure is often a precursor to personal bankruptcy in Chapter 13 to cure home mortgage arrears and save one’s home. If the SBA loan is not secured by a lien on the owner’s residence or other personal collateral, then Chapter 7 bankruptcy is often a better solution to simply discharge the SBA loan in its entirety.

The failure of a small business may quickly set in motion personal financial problems for its principal, particularly when the business owner has personally guaranteed an SBA loan and other lines of credit for the business. While the failed business may have simply closed its doors and gone defunct, the owner of the business may be left with residual personal liability long after the business operations have ceased. Particularly if the SBA loan cannot be repaid or compromised in settlement, the principal may consider a personal bankruptcy to discharge their guarantee and protect their personal financial affairs, home and other assets.

For information about how to save your small business, see Intro to Chapter 11 Business Reorganization: The Process, Time and Fees Involved.

To understand if bankruptcy protection is right for you, contact Wartchow Law Office for a free consultation to analyze your circumstances and offer practical guidance on your options in both Chapter 7 and Chapter 13 bankruptcy and bankruptcy alternatives. Located in Edina, Minnesota, Lynn Wartchow represents clients in all Chapters of bankruptcy in Minneapolis, St. Paul, Ramsey and Hennepin County, and throughout Minnesota.

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