Here’s what happens if a business closes after receiving a PPP loan
Jovita Carranza, head of the Small Business Administration, listens during a panel discussion with governors and small business owners.
Alex Wong / Getty Images
Millions of small businesses have secured federal help to weather the recession caused by the coronavirus pandemic.
Despite this relief, many do not expect to survive the crisis.
Entrepreneurs who are closing their doors may wonder if they will be forced to pay if their business received a Paycheck Protection Program loan or an economic disaster loan.
“I think this is going to become one of the biggest problems [for loan recipients]”said Nick Oberheiden, a Dallas-based lawyer.” I got the loan, I’m going out of business, now what happens to my loan debt? “
Nearly a quarter of small businesses have considered closing their doors permanently because of Covid-19, and 12% face potential bankruptcy, according to a survey released last week by Small Business for America’s Future.
Here’s a silver lining: PPP loans and disaster loans under $ 25,000 have relatively favorable terms for borrowers, experts say. And, in the event of bankruptcy, the loans can usually be canceled, they said.
But there are important caveats, especially for larger loans made under the EIDL program.
The Paycheck Protection Program, created by the CARES Act enacted in March, provides 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 financing since the start of the crisis.
All PPP and EIDL loans up to $ 25,000 do not require collateral or personal guarantees from the business or business owner.
Thus, in the event that a borrower cannot repay the loan and defaults, the lender would generally not be able to seize business or personal property.
However, the risk of default is not to be taken lightly, experts say.
The creditor – in this case, the federal government – can report the company to credit rating companies, which could 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 option of seizing assets held by the federal government, such as business income tax refunds or any other amount owed by the federal government, said Paul Becht, CPA, partner at Margolin, Winer & Evens.
The picture is darker for EIDL loans over $ 25,000, which are secured.
Any assets that remain in the business, such as warehouse inventory, receivables, and equipment like machinery or trucks, could be seized by the SBA to cover a contractor’s unpaid debt.
In addition, disaster loans over $ 200,000 require a personal guarantee. This means that the lender can also go after the personal assets of the business owner – cars, bank accounts, investments, and personal tax refunds, for example – to secure outstanding debt.
“It’s a much more frightening proposition,” Becht said of personal guarantee for an EIDL loan.
According to Oberheiden, companies that want to avoid a default can instead seek bankruptcy protection.
He advocates filing for Chapter 11 bankruptcy under the Small Business Reorganization Act, which allows “small businesses to reorganize very quickly and without bureaucracy while they are under bankruptcy protection”.
PPP and EIDL loans can generally be discharged in bankruptcy, said Michael Brauneis, managing director and head of the North American financial services group at Protiviti, a consultancy firm.
However, complications can arise, especially with PPP loans, which could impact a borrower’s ability to get their loans paid off, Brauneis said.
The SBA and the Treasury Department quickly created guidelines and application forms in their rush to distribute federal relief funds to struggling businesses, which has led to different policies and approaches to reviewing applications among banks.
One of the risks for bankrupt borrowers is that if the SBA or the bank investigates and finds errors on the part of applicants in the initial application process, it could potentially jeopardize the ability to cancel a loan, a. Brauneis said.
“As some of these loans start to turn sour, this will be the big debate or litigation in the litigation,” Brauneis said. “Who owned the error? What should the banks have done? What should the borrowers have done?
There is a similar but lesser concern with EIDL loans, as these loans are issued by the SBA and banks do not act as intermediaries like with PPP loans, he added.
However, EIDL loans over $ 200,000 come with additional risk due to the personal collateral as the business owner (in addition to the business) may need to seek bankruptcy protection. that the debt be paid, the experts said.
The question of what happens to the debt could ultimately be a moot point for PPP borrowers. This is because the federal government can waive the entire loan anyway if it is used in accordance with the program guidelines for factors such as salary costs and the overall loan term.
However, the issue is not entirely clear and may depend on factors such as when bankruptcy proceedings are initiated and when a business requests a loan forgiveness, experts said.