Even with such assistance, many small businesses face the possibility of closing their doors due to unpaid government loans and other obligations. Paycheck Protection Program (“PPP”) loans and Economic Injury Disaster Loans (“EIDL”) are just two examples of the government assistance that small businesses have relied on to survive the economic fallout of the COVID-19 pandemic. This blog highlights some factors that small business owners and their advisors should be aware of when closing down companies with open PPP loans, such as reputational risk and risk to federally held assets.
Small businesses affected by the global pandemic received hundreds of billions of dollars in forgivable and low interest grants and loans administered by the Small Business Administration (“SBA”) under the Coronavirus Aid, Relief, and Economic Stimulus (“CARES”) Act legislation passed by Congress in March of 2020 to help them weather the upheaval. By some estimates, however, up to 25% of small U. S. businesses still will not survive.
Even though PPP loans and EIDL related to the Coronavirus are generally forgiven, there is currently a lot of litigation going on and it is not yet clear how such loan default will be treated through reorganization. Certain entities facing ongoing financial hardship may decide to seek Chapter 11 or another type of bankruptcy protection.
Some small business debtors will shut down their operations without going through reorganization, before receiving forgiveness for or paying back the money they received through the PPP loan and/or EIDL programs. What will happen if these companies, their owners, and affiliates default on their EIDL and PPP loans as a result of business closure? is still very uncertain. We do know, however, that the size of the outstanding government loan(s) will largely determine the impact of the PPP loan and EIDL default.
Small Loan Default
Since personal guarantees and collateral are not required for PPP loans and EIDL of $25,000 or less, the vast majority of defaults on these small loans won’t result in the seizure of the personal assets of the business owners. Additionally, large percentages of these loans are forgivable. Therefore, the risk of default on a small PPP loan and EIDL is low for borrowers. But there are issues that these businesses need to be aware of. The impact on federally owned assets and reputation are the two main factors for small businesses defaulting on small PPP loans.
The government “lender” who provided a loan to a company that later defaulted may inform credit rating agencies about the company. This could have a negative effect on the credit scores of affiliated businesses and/or people, including the small business owner, making it more difficult and expensive to get credit in the future.
Furthermore, the federal government lender may seize any assets owned by the defaulting company, including any pending income tax refunds, in the event of default.
Larger Loan Default
A small business that defaults, along with its owners and affiliates, is at a significantly greater risk if it receives PPP loans or EIDL of more than $25,000. EIDL may present a particular risk because they typically offer less forgiveness than PPP loans and are therefore more likely to still be in existence when a small business needs to close. The specific loan terms, particularly whether the loan is collateralized and/or requires personal guarantees, have a significant impact on the level of risk.
In this scenario, collateral like inventory or manufacturing equipment could be seized to satisfy or partially satisfy outstanding debt of the borrower while personal assets of the business owner like her home and car are typically safe from seizure. For example, most EIDL between $25,000 and $200,000 do require collateral but typically do not require personal guarantees.
Most loans over $200,000 require personal guarantees and are collateralized; in these situations, bankruptcy is typically a better option for the guarantor who will lose their personal assets if the SBA comes knocking.
Small business debtors and their advisors have yet to receive comprehensive guidance from the SBA on how PPP loans and Coronavirus-related EIDL debt will be handled in bankruptcy and in cases where reorganization is not sought but the debtor must shut down its doors. It has indicated that it will make use of its powerful enforcement capabilities to safeguard government funds lent through the EIDL and PPP programs but not repaid. However, the COVID-19 crisis’ political and policy implications could affect how such saber rattling for failing small businesses manifests in practice.
To reduce the amount of debt at issue, all small businesses should make an effort to seek out and complete any PPP loan and EIDL forgiveness opportunities. The simplest and cleanest way to avoid the pitfalls of loan default is through forgiveness. Businesses with loans under $25,000 should be aware of possible effects on their reputation and federal assets in the event of default, but they can be reasonably confident that additional risk is minimal. Prior to taking any steps to close their business and default on their PPP loan and EIDL debt, borrowers of higher amounts should carefully consider and understand the terms of their loan, especially with regard to collateral and guarantees.
What happens if you can’t pay back the EIDL loan?
The lender will first ask the company for payment of the remaining loan balance. However, the lender will foreclose on the business’s pledged collateral if the borrower is unable to make the full payment. Your business assets may not have much value. In that case, the lender will abandon the collateral.
Are you personally liable for an EIDL loan?
The SBA waived any personal guarantee on advances and loans under $200,000, so I don’t have to provide one. Personal guarantees may be required by the SBA for loans exceeding $200,000
Will EIDL loans ever be forgiven?
EIDL loans cannot be forgiven. However, EIDL loans do have a deferment period. The maturity date of any EIDL loan approved in 2020, 2021, or 2022 may be postponed for up to 30 months. While not required, full or partial payments can be made now.
What happens with EIDL loan if business closes?
You are responsible for the debt even if your company shuts down the following week. Here’s another very important facet of the EIDL loan. These loans are not intended to be forgivable. In other words, it is expected that you will pay a small amount each month for 30 years even though they are not intended to be fully forgiven.