Jovita Carranza, head of the Small Business Administration, listens during a round table with governors and small business owners.
Alex Wong / Getty Images
Millions of small businesses have received federal aid to help weather the recession caused by the coronavirus pandemic.
Despite that relief, many do not expect to survive the crisis.
Entrepreneurs who close their doors may wonder if they will be hard-pressed if their business received a Paycheck Protection Program loan or an Economic Injury Disaster Loan.
“I think this will become one of the biggest problems [for loan recipients]”said Nick Oberheiden, a Dallas-based attorney.” I received the loan, I’m going bankrupt, what about my loan debt? “
Nearly a quarter of small businesses have considered closing their doors permanently due to Covid-19, and 12% are facing possible bankruptcy, according to a survey published last week by Small Business for America’s Future.
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Here’s a silver lining: PPP loans and disaster loans under $ 25,000 have relatively favorable terms for borrowers, according to experts. And, in the event of bankruptcy, the loans can generally be paid off, they said.
But there are important caveats, especially for larger loans made through the EIDL program.
The Payment Check Protection Program, created by the CARES Act legislation enacted in March, offers forgivable loans to small businesses.
The disaster loan program existed before the pandemic. The CARES Act updated it to provide emergency grants of up to $ 10,000 to small businesses.
The Small Business Administration, which administers the loans, has distributed nearly $ 630 billion in combined funds since the crisis began.
Default loans
All PPP and EIDL loans of up to $ 25,000 do not require collateral or personal guarantees from the business or business owner.
Therefore, in the event that a borrower is unable to repay the loan and defaults, the lender will generally not be able to seize business or personal assets.
However, the risk of default on a loan should not be taken lightly, experts said.
The creditor, in this case, the federal government, can report the business to the credit rating companies, which could adversely affect the ability to borrow again and increase its interest rate on any future debt.
The federal government, unlike a typical creditor, also has the ability to confiscate federal assets, such as a company’s income tax refunds or any other amount owed by the federal government, said Paul Becht, CPA, a partner at Margolin, Winer & Evens.
The picture is darker for EIDL loans that exceed $ 25,000, which are guaranteed.
The SBA could seize any assets that remain in business, such as warehouse inventory, accounts receivable, and equipment such as machinery or trucks, to cover an entrepreneur’s outstanding debt.
Additionally, disaster loans exceeding $ 200,000 require a personal guarantee. That means the lender can also go after the business owner’s personal assets (cars, bank accounts, investments, and personal tax refunds, for example) to secure outstanding debt.
“That is a much more terrifying proposition,” Becht said of the personal guarantee of an EIDL loan.
Bankruptcy
According to Oberheiden, companies that want to avoid default on a loan may seek bankruptcy protection.
He advocates filing for bankruptcy under Chapter 11 under the Small Business Reorganization Act, which allows “small businesses a really fast, non-bureaucratic reorganization while bankrupt.”
PPP and EIDL loans can generally be repaid in bankruptcy, said Michael Brauneis, managing director and leader of the North American financial services group at Protiviti, a consulting firm.
Whose mistake was it? What should banks have done? What should the borrowers have done?
Michael Brauneis
managing director at Protiviti
However, complications can arise, especially with PPP loans, that could affect the borrower’s ability to obtain loan repayment, Brauneis said.
The SBA and the Treasury Department quickly created guidelines and application forms in their rush to get federal aid funds out of troubled businesses, leading to different application review policies and approaches among banks.
The ‘great debate’
One risk to bankrupt borrowers is that if the SBA or the bank investigates and finds errors on the part of applicants in the initial application process, that could put the possibility of a loan being canceled at risk, Brauneis said.
“As some of these loans begin to deteriorate, that will be the big debate or dispute in the litigation,” said Brauneis. “Whose mistake was it? What should banks have done? What should borrowers have done?”
There is a similar but lesser concern regarding EIDL loans, as those loans originate from the SBA and banks do not serve as intermediaries as with PPP loans, he added.
However, EIDL loans that exceed $ 200,000 carry additional risk due to personal collateral, since the business owner (in addition to the business) may need to seek bankruptcy protection for the debt to be canceled, experts said.
The question of what happens to debt could be a moot point for APP borrowers. This is because the federal government can forgive the entire loan anyway if it is used according to program guidelines around factors like payroll costs and the overall length of the loan.
However, the problem is not entirely clear and may depend on things like when bankruptcy proceedings are initiated and when a company applies for loan forgiveness, experts said.
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