Commentary

June 25th, 2020

What Happens to Loans Should Small Businesses Fail?

Small businesses play a key role in the US economy. In fact, there are approximately 30 million small businesses, which employ more than 60 million people. With the recent economic impact of COVID-19, small businesses have suffered tremendously. In a survey conducted by Small Business for America’s Future, 53 percent of the survey respondents took on new debt related to COVID-19. While one in four respondents have a new debt of above $20,000, 18 percent took on new debt of more than $100,000. Given the current economic situation, small business owners are worried about losing their business and what that will mean to their loan liability should that take place.

The Paycheck Protection Program (PPP) was created by the CARES Act, which was enacted in March 2020. The program offered forgivable loans to small businesses suffering due to the global pandemic. The Economic Injury Disaster Loan (EIDL) program, however, existed before the pandemic. This program was updated through the CARES Act to provide emergency grants to small businesses consisting of up to $10,000. Since the crisis began, small businesses across the U.S. have received a total of $630 billion through both programs. Despite the relief offered by the programs, many small businesses do not expect to survive the economic crisis brought by COVID-19. Interestingly enough, per a survey conducted by Small Business for America’s Future, almost a quarter of small businesses are considering closing permanently due to the pandemic.

However, there may be a slight silver lining. PPP loans and EIDL loans less than $25,000 may be discharged in the event of bankruptcy. But there are also intricacies and limitations due to the haste in which the relief plans were deployed. 

Loan Defaults

PPP and EIDL loans of up to $25,000 will not require collateral or guarantees from the business or business owner. Therefore, if a borrower cannot repay the loan and the defaults, lenders will not be able to seize the business or personal assets.

Yet, the risk of a loan default is that the creditor is the federal government. This means that they could potentially report businesses to credit scoring organizations, thus negatively affecting the capability to borrow in the future. Furthermore, it could also lead to an increase in interest rates on future debt. Lastly, the federal government can collect assets such as the business’ income tax refunds and other amounts that are due from the side of the from the federal government. 

Unfortunately, those who received an EIDL loan that exceeded $25,000, are subject to have the remaining assets seized by the Small Business Administration to cover the outstanding debt. Furthermore, EIDL loans consisting of more than $200,000 are subject to a personal guarantee. This means that a business owner’s personal assets can be used to obtain outstanding debt. This includes, but is not limited to bank accounts, personal tax refunds, investments, and cars.

Bankruptcy

For those who wish to avoid default, experts suggest small businesses to consider bankruptcy protection. Under the Small Business Reorganization Act, Chapter 11 bankruptcy offers a favorable option by lowering costs, simplifying procedures, and proving greater flexibility in plan confirmation requirements to help small businesses regain control of their operations. 

Complications are not out of the question for small businesses who turned to PPP loans as their lifeline. Due to the haste, banks took several approaches and application review processes. Should a bank or the SBA investigate and find errors within the applications, there could be a possibility to put the discharged loan at risk.

Although there is a similar worry for EIDL loans, the SBA originated those loans and there are no middlemen. However, as mentioned earlier, these loans come with an increased risk due to the personal guarantee. The business and owner might find themselves seeking bankruptcy protection to ensure their debt is discharged.