You may be able to work out a new payment plan. These solutions may not be ideal but they can help you avoid a lawsuit and curb the damage to your credit score. Filing bankruptcy could help you restructure the debt or eliminate it completely, depending on how your business is structured. So if you have little to no assets and no way to repay the loan, Chapter 7 could wipe the debt out so you can start fresh.
On the other hand, if you operate as a corporation or LLC , then Chapter 11 might make more sense. A Chapter 11 bankruptcy filing can help you restructure your business debt and pay it off without having to close your doors or sacrifice business assets. Talking to a bankruptcy attorney or credit counselor can help you compare all of the options for managing a defaulted business loan.
And in some cases, it can also affect your personal financial situation. DesMarteau said it's rare that a traditional bank would approve a loan without some form of collateral to secure it.
Unsecured loans are more common with arm's-length lenders than with standard banks, and they usually require a personal guarantee from the business owner. In many instances of an unsecured loan, business owners are required to sign a personal guarantee, which is a legally binding statement that allows the lender to file with a court to seize and liquidate personal assets to cover the loss. Defaulting on a loan when you've signed a personal guarantee will likely impact your credit score for up to 10 years.
If you default and you haven't signed a personal guarantee, your business's credit score will be impacted. If you put up collateral, you will lose whatever asset you put up. Most business loans require a personal guarantee, which can serve a great purpose for some loan situations — it's an easy way for a business to get funding when it may not qualify for a loan from a traditional bank. There are some business loans and lines of credit that you can get without a personal guarantee, though they generally have higher interest rates.
It is possible to get rid of a personal guarantee by filing for bankruptcy, and most personal guarantees do qualify for discharge. However, if it is a nondischargeable debt, you cannot use bankruptcy to remove your personal guarantee. Furthermore, filing bankruptcy on behalf of the business will shift the responsibility for paying back the loan from your business to you personally, and the lender will look to you and your personal assets for the money.
When a contract with a personal guarantee is breached, such as when you default on a loan, the lender can go directly to the guarantors and are not required to exhaust other options against your business before doing so.
As such, it is vital to understand the ramifications and the agreement structure before signing anything with a lender. Goldenberg said that some merchant cash advance companies, which are lenders that provide cash advances against credit card receivables, may require borrowers to sign confessions of judgment.
These COJs mean the lender can expedite the legal process, freezing assets or placing liens against personal assets immediately after default is triggered. Small Business Administration loans are from banks backed by the government. This is a program for businesses that may not otherwise qualify for loans with banks or alternative lenders because of financial hardship.
If you default on an SBA loan , you're still on the hook to cover the lender's loss. DesMarteau said that SBA loans almost always require collateral, which can be liquidated in the event of default. If the business owner defaults, the government organization might force a liquidation of all collateral to repay the debt.
The lender will call in the SBA guarantee only when its efforts to collect payment from you fails. Lenders' efforts generally include contacting borrowers after a day grace period and possibly charging a late fee, but different lenders have varying policies on how they treat late payments.
A lender might allow a borrower to restructure the loan or deliver interest-only payments for a certain period of time. If a lender calls on the SBA for the guarantee and the federal government takes a loss on the loan, it may take additional measures to repay the loss, such as garnishing the borrower's wages or freezing their bank account.
The best thing you can do as a borrower is contact your lender when you start missing payments. If you're transparent with them, most lenders will work with you in some way.
As for other resources, the National Foundation for Credit Counseling provides small business owners and individuals with free legal counseling and resources. It can be a great place to start if you're looking for more guidance on a loan dispute. Another important thing to consider is the type of lender you're dealing with. Rodney Ramcharan , an associate professor of finance and business economics at the USC Marshall School of Business, echoed what Goldenberg said about traditional banks.
Working with traditional or local banks gives you a greater chance that you'll be able to work through issues as they arise. Goldenberg said arm's-length lenders, such as MCAs, have different funding practices and may be in a position where their primary concern is just getting their money back.
Some of these remedies are dependent on the inclusion of express terms in the underlying loan documents. Others derive from caselaw or statutory authorities. Regardless, the parties should consider, during the initial negotiation process, what should happen if material changes in circumstances occur. This will give the parties the opportunity to structure their agreement in a way that protects their respective interests and streamlines resolution processes.
If the parties fail to consider these issues at the start, the way forward may be uncertain, with the only certainty being increased risk and cost. An initial area of negotiation should involve loan covenants, which are terms that require the borrower to fulfill certain conditions or avoid certain actions. They may be financial covenants tied to the borrower's operations, such as maintaining a certain debt-to-equity ratio, level of cash flow, or earnings before interest, taxes, and depreciation.
The commercial real estate lender needs to ensure that the business attendant to the real estate will service the debt through full and timely payments and fulfill other obligations. These covenants, which are essentially canaries in the coal mine, are material and can trigger events of default if the borrower fails to comply with them.
They are therefore integral to the ongoing relationship between the lender and the borrower. Note that numerous factors, including loan-to-value ratio, the current state of the market and availability of credit, and the track record of the property, may affect the terms and covenants that a lender requires in a given transaction.
Loan terms and covenant requirements may also vary based on the type of lender involved. So-called hard money lenders—usually private investors or a pool of passive investors creating a managed fund—may take a different approach than conventional lenders. Hard money lenders may invest in individual loans or in a fund that manages a portfolio of loans. This differs from conventional lenders—such as banks or credit units—which usually tie such loan terms to the borrower's ability to repay from ongoing income.
If the loan defaults, hard money lenders often expect to be repaid by taking the collateral and selling it. In doing so, they foreclose on the entire real property serving as collateral and forfeit interest payments that the borrower may have made in the future.
Lenders tend to structure commercial real estate loans as non-recourse loans. A non-recourse loan is secured by real estate and possibly other collateral.
When a loan is structured as non-recourse debt, the borrower is not personally liable for the debt or the lender's losses except in the case of specific bad acts e. These bad acts are called non-recourse carve-outs. Of course, the borrower in a commercial real estate transaction may be a single purpose entity SPE , set up to own and operate a single real estate asset.
In such circumstances, recourse from the borrower may be inherently limited in any event. The lender may therefore require the sponsor to provide a guaranty, known as a non-recourse carveout guaranty or a bad boy guaranty, to cover the lender's losses resulting from the borrower's bad acts. The loan documents for a non-recourse loan may limit the lender's enforcement of the loan to an action in foreclosure.
Further, they may require the lender to look solely to the real property and other collateral securing the loan and limit the lender's potential recovery to the amount of the debt. Bad boy carve-outs to this non-recourse feature may extend the borrower's and guarantor's liability to the lender's actual losses resulting from an impairment of the collateral's such as waste of the collateral or failure to pay property taxes or for events that impair the lender's ability to realize upon the collateral such as a borrower's bankruptcy that stays foreclosure proceedings.
Commercial lenders typically just want to be repaid and do not want to take ownership of the real property. Acquiring other real estate owned OREO property i. See, for example, the regulations that the Office of the Comptroller of the Currency has issued covering OREO activities for national banks and federal savings associations. These and other regulations, which seek to mitigate the impact of real estate losses and ensure the safety and soundness of the banking institution, can trigger additional reserves against capital, which in turn may limit further lending capacity.
For these reasons, commercial lenders usually do not want to own and operate real property and may instead be inclined to pursue a loan workout with the borrower. When a commercial loan is structured as recourse debt, on the other hand, the borrower is personally liable for the debt. If money remains due after the mortgaged property is sold through a judicial foreclosure, the lender may pursue a deficiency judgment against the borrower for the balance.
This allows the lender to collect what is owed for the debt even after the lender has foreclosed on the mortgaged property. Sometimes, a surety or guarantor can guarantee performance or payment of the loan.
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