When small businesses around the country applied for federal aid in the form of Paycheck Protection Program (PPP) loans, they did so in the belief that the coronavirus crisis would be short-lived and that they’d be able to reopen their doors relatively quickly. Unfortunately, that view was overly optimistic, and five months later, many of those businesses have been forced to close their doors permanently, while others face an uncertain future. That has left those who took out Paycheck Protection Program loans and Economic Injury Disaster loans unsure of what their obligations are.
Paying off a loan with no source of income represents an obvious hardship, and in some cases an impossible situation. A Small Business for America’s Future survey indicates that almost 25% of small businesses in the United States are trying to decide whether they can continue operating as a result of the impact of COVID-19, and 12% are considering filing for bankruptcy.
If you find yourself in this precarious, frightening position, here are a few important points that may make you feel a tiny bit better. Experts say that businesses that took out either disaster loans or PPP loans with a value of less than $25,000 not only received highly favorable terms, but in most cases those debts are dischargeable. Those who took out EIDL program loans with higher values may find themselves facing significant challenges.
Unfortunately, that is not the case with all of the loans that were extended. The two types of loans that have been extended to help businesses through COVID-19 are the Paycheck Protection Program, which was specifically created in March to provide forgivable loans to small businesses as part of the CARES Act, which created emergency grants of up to $10,000 for small businesses, and the already existing disaster loan program. All of the loans are administered by the Small Business Administration, which has so far provided almost $630 billion between the two loan types since the pandemic started.
How a default is handled and how it will affect you largely depends upon the type of loan that you took out. Businesses and business owners were not asked to put up collateral or even to provide personal guarantees for loans up to $25,000, so a default will not threaten their personal assets or those of their business. Still, a default can always affect your credit score if it is reported to the scoring companies, and the federal government has the right to do so. Whether they will or not remains to be seen, but you do need to keep the potential impact in mind. It might affect your ability to borrow again, and if you can borrow is likely to significantly increase the interest rate you have to pay. The government is also in the unique position of being able to recoup some of their losses by seizing assets that they hold, including your company’s income tax refunds, or holding on to any monies that the federal government may owe to the entity that defaults.
According to experts, PPP borrowers may end up finding that loans are forgiven in their entirety, making the question of what happens in case of default entirely beside the point. The original intention of the program was for the loans to be forgivable as long as businesses adhered to the program’s guidelines regarding how the money was spent (largely on payroll.)
By contrast, businesses that took out bigger loans, and particularly EIDL loans over $25,000, were required to put up collateral in exchange for the monies that they received, and that means that they face the distinct possibility that assets such as their receivables, valuable equipment like trucks and machinery, and even inventory held in a company’s warehouse is fair game for seizure by the Small Business Association in response to a default. And those businesses that took out loans over $200,000 were asked to provide a personal guarantee as collateral for their debt, putting the business owner’s personal assets including personal tax refunds, bank accounts, investments and vehicles at risk of seizure. That means that the business owner, and the business itself, may need to consider filing for bankruptcy protection if they are unable to pay their debt.
As is true with personal debt, if a business is facing real challenges in paying back their loan they have the option of filing for Chapter 11 bankruptcy under the Small Business Reorganization Act. Doing so provides a good option to take a breath and reorganize debt without having to default and allows for the discharge of both PPP and EIDL loans in most (but not all) cases.
The challenge in determining whether PPP and EIDL loans can be discharged in bankruptcy centers on the diverse application guidelines and forms that were created in the initial panic of the COVID-19 crisis. Different lenders have different review policies and terms, so it is important to make sure that the relief funds that you received can be discharged in bankruptcy.
The other consideration is whether all information provided on the initial application was accurate. The SBA or the individual lender facing the reality of a discharge in bankruptcy is likely to investigate to ensure that the borrower originally acted in good faith and they could interpret mistakes or errors as intentional. The initial rush and subsequent confusion of the process make it highly likely that many in these situations will find themselves facing litigation. Similar possibilities exist with EIDL loans, which have been around longer, but which were still initiated in the midst of a frenzy of activity.
If you have questions about your PPP or EIDL loans and which options are (or are not) available to you, we recommend you contact your business accountant or tax professional.
About Sonu Shukla, CPA, CFP
Sonu Shukla is a Certified Public Accountant as well as Certified Financial Planner. He believes in proactive tax planning and has the skills, education and experience to demonstrate passionately planned financial strategies. His firm tailors highly efficient tax plans for his small business clients, all in a one on one environment where he and the client can bounce ideas around until every detail is worked out. Located in Orlando, FL, he services all of Florida.
