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The Small Business Administration (“SBA”) is a federal agency that guarantees or originates certain business loans. Generally, the SBA insures business loans made by a local lender at up to 85% of the original loan balance. The SBA does lend directly under certain limited circumstances through either an Economic Injury Disaster Loan (EIDL) or a Physical Disaster Loan. In both instances, the SBA must first determine that the business cannot obtain credit elsewhere. Another type of direct loan was the COVID-19 EIDL – that program stopped taking new applications back in January 2022.  

What Constitutes an SBA Loan Default

Defaulting on an SBA loan can be a daunting experience for any business owner. The repercussion of a default requires strategic planning and proactive measures. Before discussing different options, it's essential to understand what constitutes default on an SBA loan. Typically, default occurs after a borrower fails to make payments for at least 120 days. This can result from various factors such as cash flow problems, economic downturns, changing marketplace, or operational setbacks.

Avoiding an SBA Loan Default

Missing a few payments means the SBA loan is delinquent but does not necessarily result in the lender placing the loan into default status. The lender will usually reach out to see if there is a way to work out the loan and bring it back current within a reasonable period. This is the time to be pro-active before an SBA loan default occurs. Typical options include loan deferments, loan restructuring and Offer in Compromise (“OIC”). A deferment, sometimes called a forbearance, is possible if the borrower can establish that a temporary payment relief, usually no more than 6 months, will enable the borrower to improve cash flow so that it can resume payments.

A restructuring of an SBA loan involves revising the terms of the loan, such as extending the repayment period or adjusting interest rates, to make payments more manageable for the borrower. An OIC typically involves a lump-sum offer from the borrower to satisfy the entire loan obligation and will require a significant amount of financial information from the borrower and any guarantors, as well as the liquidation of any collateral.  

What Happens When an SBA Loan is Placed into Formal Default

Once the SBA loan is placed into formal default by the lender, the process generally will play out differently depending on whether there is a local lender or if it is a direct SBA loan. With a local lender, the first step typically is a demand letter formally defaulting the loan and requiring immediate repayment of the entire amount due. Depending on the loan terms, the lender must give a certain amount of time to make the payment in full, typically 30-45 days. Once that deadline passes, the next step is seizure of the collateral for the loan such as business bank accounts, accounts receivable, real estate, machinery, inventory, and/or equipment.

Seizure of collateral may also involve a lawsuit, either as part of the foreclosure process against real estate, or after sale of the collateral in order to determine the deficiency amount if the collateral is not sold for an amount sufficient to payoff the loan in full. Judgements in New York are enforceable for up to 20 years and can also be used to place a lien on other real estate that may be owned by the debtor. It is at this stage most local lenders will recoup the remaining amount of the insured balance from the SBA and formally turn the remaining debt over to the SBA.       

The SBA direct process is similar; however, the SBA has some powerful tools that local lenders do not. First, the SBA will require that the collateral be liquated, and the proceeds turned over. Assuming there is still an amount due that cannot be paid in full, the SBA will entertain an OIC. The SBA offers an OIC program for borrowers facing financial hardship. This program allows eligible borrowers to settle their debt for less than the full amount owed, provided certain criteria are met. Applying for an OIC requires thorough documentation and proving that not only is the business shut down and liquidated, but also that the borrower’s personal financial situation is bleak.

If an OIC is unsuccessful, then the SBA can issue a notice to the Treasury Offset Program (“TOP”) and/or an Administrative Wage Garnishment (“AWG”) notice directly to an employer. The TOP authorizes the federal government to take a portion of any federal wages or Social Security benefits owed to the borrower, as well as seizing in full any vendor payments or income tax refunds. The AWG allows wages to be garnished up to 15 percent of disposable income which is essentially the net pay after deductions. Although both local lenders and the SBA must sue within 6 years of the default if they wish to obtain a judgment against the borrower, there is unfortunately no statute of limitations for either TOP or AWG. Either can occur more than 6 years after the default and they will remain in place until the debt is paid in full, including interest and collection fees.

In Formal Default on an SBA Loan? Consider Bankruptcy

One effective way to deal with a defaulted SBA loan is to consider filing for bankruptcy relief. Bankruptcy is a powerful tool available to businesses and guarantors that can assist in either reorganizing business operations to cure the default and continue operating, or to clear out the debt altogether if the business operations have ceased and repayment is not possible.

Bankruptcy will prevent or stop collection activity, including TOP and AWG. Dealing with defaulted SBA loans requires a combination of proactive communication, strategic negotiation, and careful financial planning. By understanding the options available and taking decisive action, small business owners can navigate this challenging situation.

How a Business Bankruptcy Lawyer Can Help

McConville Considine Cooman & Morin has the expertise to assist both debtors and creditors in all aspects of bankruptcy. We have decades of experience representing people and companies in bankruptcy court and can assist you with your financial issues and help guide you through the bankruptcy process from start to finish. As a federally designated Debt Relief Agency, we assist people and companies with finding solutions to their debt problems, including, assisting them with the filing of petitions for relief under Title 11 of the United States Bankruptcy Code. 

If you would like to schedule a consultation to talk about how this may impact your business,  please feel free to contact Mikal J. Krueger at mkrueger@mccmlaw.com or 585-512-3546.

This publication is intended as an information source for clients, prospective clients, and colleagues and constitutes attorney advertising. The content should not be considered legal advice and readers should not act upon information in this publication without individualized professional counsel.

About MCCM

McConville Considine Cooman & Morin, P.C. is a full-service law firm based in Rochester, New York, providing high-quality legal services to businesses and individuals since 1979.  With over a dozen attorneys and a full paralegal support staff, the firm is well-positioned to right-size services tailored to each client. We are large enough to provide expertise in a broad range of practice areas, yet small enough to devote prompt, personal attention to our clients.

We represent a diverse range of clients located throughout New York State and New England.  They include individuals, numerous manufacturing and service industry businesses, local governments, and health care professionals, provider groups, facilities and associations. We also serve as local counsel to out-of-state clients and their attorneys who have litigation pending in Western New York courts.  For more information, please contact us at 585.546.2500.