The pandemic managed to turn everything upside, which caused a lot of people and businesses to struggle. Companies were able to get a loan through the Paycheck Protection Program to help them overcome this extraordinary time. With a PPP loan, companies can keep people on staff even as the business slowed down due to the virus. About 66.7% of companies applied for this assistance, which is a forgivable loan for businesses with fewer than 500 employees if 75% of the borrowed money went towards leave/severance pay, salary, and payroll. The other 25% must have been used towards operating costs. This program helped make sure 51 million people retained their jobs during the crisis.
But what happens if those businesses end up closing even after receiving this help?
Despite Help, Businesses May Still Close
Even with this generous help, businesses still struggled to remain open. Some are wondering what will happen to them if they take a PPP loan but ultimately still don’t survive the economic crisis caused by the pandemic.
The good news for borrowers is that the disaster loans and PPP loans that are smaller than $25,000 have terms that are pretty favorable for the borrowers. If bankruptcy occurs, these loans are typically able to be discharged. However, some crucial caveats need to be considered, particularly if you have one of the larger loans from the EIDL Program. The loans through the PPP from the CARES Act are forgivable, as long as you meet defined specifications.
What Happens if Your Business Defaults on Your Loan?
The good news is that you don’t need to put up collateral or personal guarantees for PPP and EIDL loans up to $25,000. What this means for you is that the business owner won’t have any collateral or personal assets seized in case they default on loans. However, you need to consider it before you decide to default on these loans.
If you default on the loan, the creditor (the federal government) can report your default on the loan to credit scoring companies, which will negatively impact your credit and can lead to higher interest rates on any further debts you may incur. Another thing to consider is that since the creditor, in this case, is the federal government, they can seize any federally held assets, unlike other creditors. These assets include the business’ income tax refunds or any additional money that they are owed from the federal government.
Defaulting on these loans can be even more problematic if you received an EIDL loan that was worth more than $25,000. These loans do require collateral, so any assets that remain in the business, such as any inventory in the warehouse or account receivables, could be seized by the Small Business Association to cover the debt that you owe.
Any disaster loans that are worth more than $200,000 will also require a personal guarantee. What this means is that the lender can go after the personal assets of the owner. Such assets can include their car or home, which were used to secure the debt.
What if I File for Bankruptcy?
Instead of defaulting on loans, businesses may look into their bankruptcy options. This option is better than defaulting for most companies. It’s recommended that companies file for Chapter 11 bankruptcy, filing under the Small Business Reorganization Act. Filing for Chapter 11 gives businesses a quick reorganization process without the hassles of bureaucracy during their time under bankruptcy protection. For the most part, EIDL and PPP loans can be discharged with a bankruptcy. Unfortunately, some things can stand in the way of getting these loans removed.
The Treasury Department and the Small Business Association created the forms and guidelines for these loans fast, which lead to some confusion from the different lenders. Because of how quickly these forms and guidelines were created, it means that each lender has their own policies and approaches to these loans.
The Major Debate About These Loans
A significant risk borrowers face when going through the bankruptcy process is that if the Small Business Association or the bank lender finds any error on the application for these, loans the borrower might not get their loan discharged on a technicality. These errors could cause a significant problem during the litigation. There are so many things that could have gone wrong, but no one quite knows who to blame for these mistakes.
Such errors are also a concern for EIDL loans, but it’s not as severe since the SBA and not a bank originate these loans as they are with PPP loans. The more significant risk for those people with EIDL loans is that if they borrowed over $200,000, the business owner would have risked their personal assets.
So what happens with these loans? No one knows, but for the most part, PPP loans are forgiven as long as the business followed the guidelines for the loans. However, there are various factors, such as when the company files for loan forgiveness or start their bankruptcy proceedings.