June 25th, 2020
New Bankruptcy Law Could Protect Small Businesses from Defaulting on Federal Loans
There are approximately 30 million small businesses in the United States, 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 said they took on new debt, as a result of COVID-19. The report also showed that one in four respondents have new debt of more than $20,000 and 18 percent have 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.
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 reason for optimism. Experts say PPP loans and EIDL loans of less than $25,000 contain promising terms for borrowers and may also be discharged in the event of bankruptcy. But there are intricacies and limitations, due to the haste in which the relief plans were deployed.
Defaulting on Loans
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 owed to 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.
For those who wish to avoid default, experts suggest that small businesses consider bankruptcy protection. Under the Small Business Reorganization Act, enacted in February 2020, Chapter 11 bankruptcy offers a favorable option by lowering costs, simplifying procedures, and providing greater flexibility in plan confirmation requirements to help small businesses regain control of their operations.
AIS, a leading bankruptcy data provider, monitors the activity of small business bankruptcy cases known as Chapter 11 Sub-chapter V and shares the information with its banking clients. Based on the data, AIS expects June Sub-chapter V bankruptcies to reach their highest monthly total since the new law was enacted in February. Most likely, that number will continue to rise into the third and fourth quarters of this year.
Generally speaking, PPP and EIDL loans can be discharged in bankruptcy. However, complications are not out of the question for small business owners.
In an effort to expedite the federal funding process, the SBA and Treasury Department created forms and guidance quickly, which led to a variation in application review policies amongst banks. Should a bank or the SBA investigate and find errors within the applications, the discharged PPP loan could possibly be at risk.
There are fewer concerns around EIDL funding since those loans were originated by the SBA. Still, EIDLs over $200,000 come with some risk, due to the personal guarantee, which could require both the business and the owner to file bankruptcy to ensure their debt is discharged.