SMALL BUSINESS ADMINISTRATION Loans: DISCHARGEABLE IN BANKRUPTCY
An SBA loan is as dischargeable in Chapter 7 or Chapter 13 bankruptcy as any other sort of unsecured debt—with a few caveats.
First, it is worth discussing why a debt may or may not be dischargeable in bankruptcy.
It is never the case that a debt is not dischargeable in bankruptcy simply because it is a debt owed to a governmental agency. If that were so, IRS and State of Michigan Department of Treasury tax debts would never be dischargeable. Michigan “Driver’s Responsibility Fees” would never be dischargeable. Fees owed for housing in Michigan prisons would never be dischargeable.
And yet they are.
Debts are dischargeable in bankruptcy in every instance in which the US Bankruptcy Code—the Federal statute governing the bankruptcy process—fails to state specifically that they are not dischargeable.
That is, unless a debt is one of the specific types of debt specifically excepted from the Chapter 7 or Chapter 13 bankruptcy discharge by Section 523 of the Bankruptcy Code, it is dischargeable.
Among the non-dischargeable debts found in that Section, such as child support or recent tax obligations, nowhere to be found are SBA or Small Business Administration loans.
Thus, an SBA loan, as a matter of personal liability, is dischargeable through Chapter 7 or Chapter 13 bankruptcy.
That means that, after a Chapter 7 or Chapter 13 process is completed, you no longer have any personal obligation to repay the debt for the remainder of your life. That doesn’t mean, however, that the business which may be co-obligated to the debt, is free and clear from SBA collections procedures.
It does not mean that the SBA does not have an opportunity to push back on your discharge of its obligations.
SBA LOANS IN BANKRUPTCY: DEBTS INCURRED BY WAY OF FRAUD
One of the types of debt listed in Section 523 of the Bankruptcy Code as not eligible for discharge in Chapter 7 or Chapter 13 bankruptcy as debts incurred through fraud.
This Section of the Code describes many different types of fraud and the circumstances under which a debt has been incurred through fraudulent means. Some types of fraud described in the Bankruptcy Code do not require any intent to defraud anybody, only requiring, instead, that certain events have come to pass.
An example is defalcation, which is a situation in which a general contractor has accepted funds from a client and then used those funds for some expense prior to paying for the materials and subcontractors required to carry out the client’s construction job. A debt owed to the client by that contractor is not eligible for discharge in bankruptcy.
In business, money changes hands. It moves from customer or client to business to supplier and so on and so on. A business transaction can be as simple as you paying me $5.00 to give you my left shoe, or it can be as complex as raising investment capital for a hedge fund’s hostile takeover of a corporation subject to extensive Federal operating regulation.
The point is that fraud is often in the eye of the beholder—or the one suffering the monetary loss. The Small Business Administration has the resources and wherewithal to examine a bankruptcy filing involving an SBA loan to determine whether the loan was applied for under fraudulent circumstances and then to argue that position in the US Bankruptcy Court.
However, when you file a Chapter 7 or Chapter 13 bankruptcy case, creditors have 60 days from the date of the hearing known as the 341 Meeting of Creditors to file an “adversary proceeding” (a lawsuit) within your bankruptcy case requesting that the Court determine whether the SBA debt should be excepted for discharge on a basis of fraud.
If the SBA allows this deadline to pass, you be rest easy as to the dischargeability of the SBA loan.
At least, if you informed your bankruptcy attorney of the loan, and the notice of Chapter 7 or Chapter 13 filing was properly noticed out to the SBA.
SBA Loans: Collateral and Business Assets Still at Issue
A personal Chapter 7 or Chapter 13 bankruptcy filed by a business owner personally will discharge their individual, personal obligations to repay debt incurred by the business which he or she may have personally guaranteed (many SBA loans do require a personal guarantee, though the PPP loans offered in response to the COVID-19 crisis do not).
That does not mean that the personal bankruptcy discharges the liability of the business entity itself, if the business has been organized as a separate corporate or other entity.
If that is so, it is important to remember that the business is a separate legal “person” which has not itself filed a bankruptcy (unless the business has filed its own Chapter 7 or Chapter 11 proceeding). It remains liable for any debt it separately owes, including SBA loans.
It is confusing for an individual who happens to operate a sole member LLC to continue to receive collection calls after a personal Chapter 7 or Chapter 13 bankruptcy on behalf of the LLC if that person generally considers that they, personally, are the business—but this is not legally so.
If the business that received the SBA funds continues to operate after its principle’s personal bankruptcy, it will remain liable for the debt.
Additionally, discharge of any secured debt (a debt with collateral attached such as a mortgage or car loan) through Chapter 7 or Chapter 13 bankruptcy will discharge the filing debtor’s personal liability for payment of the debt—but it does not “lift the lien” held by the creditor, whether it is the SBA or a commercial mortgage originator.
An SBA mortgage (and there are such mortgages) encumbering the title to real estate will remain in place after a bankruptcy is filed, unless it is properly stripped or crammed down in a Chapter 13 bankruptcy.
The assets of the business, therefore, may be subject to repossession, foreclosure, or seizure after a bankruptcy, even if the SBA cannot proceed to collect any money from the person filing the Chapter 7 or Chapter 13 bankruptcy.
SBA Loans and Bankruptcy: The Bottom Line
The bottom line is that, if you are a business with SBA or other business loans and are considering filing for bankruptcy, you should consult an experienced bankruptcy attorney—particularly if your hope is to continue operating the business during and after the bankruptcy.
Attorney Walter Metzen is a Board Certified Bankruptcy expert and has obtained successful discharges for thousands of Chapter 7 and Chapter 13 bankruptcy clients.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process and is experienced in determining and advising as to the best course of action when filing Chapter 7 or Chapter 13.