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Legal Enforceability of the SBA Note and Personal Guarantee

What defenses are available to challenge the legal enforceability of an SBA Note and Personal Guarantee?

When a small business defaults on an SBA loan, the lender or CDC will try to liquidate all pledged collateral to reduce the loan balance.  If liquidation efforts do not fully pay back the loan, the lender or CDC may file a lawsuit against the small business owners and guarantors, obtain judgment and convert the SBA loan amount into a secured debt.  The lawsuit would be based on breach of contract.  A good defense attorney will raise certain affirmative defenses and challenge the legal enforceability of the the SBA Note and personal guarantee agreement.

When the SBA has paid either the SBA guarantee monies to the lender or the CDC and has been formally assigned the loan instruments (i.e., Promissory Note, Business Loan Agreement, Personal Guarantee, Commercial Security Guaranty or Deed of Trust), then the SBA is entitled to enforce the debt against the small business guarantors.  If the SBA debt is not resolved while the SBA holds it, then it will eventually get transferred to the Treasury Department’s Bureau of Fiscal Service (Treasury/BFS) for aggressive collection.

When Treasury/BFS is assigned the SBA debt, one of the collection weapons it uses, is Administrative Wage Garnishment (AWG).  AWG proceedings require that the SBA debtor be provided with due process notice and an opportunity to be heard.  This federal agency process provides that the SBA debtor be allowed to conduct limited discovery and contest the SBA debt.  One of the defenses to the debt is to challenge its legal enforceability.  To assert a legal enforceability challenge, it is important to explore applicable affirmative defenses or excuses to a breach of contract.

Below is an explanation of defenses that may be raised to challenge a personal guarantee agreement involving an SBA loan:

What is the defense of misrepresentation or fraudulent inducement?

If an SBA debtor can show that the personal guarantee agreement was the result of fraudulent inducement by the lender or CDC (i.e., SBA debtor was induced to enter into the guarantee agreement by false information or the withholding of information that the other party was under a duty to disclose), the guarantee agreement may be voidable by the defrauded party.

What is the defense of public policy?

Certain provisions contained in a guarantee agreement may be considered void for public policy; that is, they are legally unenforceable because the subject matter of the agreement, while legal, is something in which the law has held is in opposition to the public good.

What is the defense of misunderstanding?

A misunderstanding may prevent the creation of a personal guarantee agreement where, if proven, the parties do not have the same understanding of the agreement’s material terms.

What is the defense of mistake?

Related to the defense of misunderstanding is that of mistake. There can be two types of mistake. The first is mutual mistake, where parties enter into a personal guarantee agreement while both of them are mistaken about the same basic set of facts. Generally, a guarantee agreement resulting from mutual mistake is voidable by the adversely affected party.

The other type of mistake is unilateral mistake, where one party uses words that are clear and unambiguous but has made a mistake of fact that, had she been aware of it, would have caused her to express herself differently.

What is the defense of illegality and unconscionability?

A guarantee agreement is void if it requires the performance of an act that violates a relevant law, such as a statute or regulation.  A guarantee agreement may be unenforceable if it contains unconscionable elements, or terms that would lead to a result that offends justice.

What is the defense of duress and undue influence?

All agreements involve some degree of threat, such as the threat of a failed business deal. It can be difficult to draw a line between a legitimate threat and undue duress. Generally, however, threats to engage in legal activity (such as filing a lawsuit) do not constitute duress.  Agreements made under duress are voidable by the party against whom certain types of threats are made.

Undue influence is a related concept, which occurs when one person takes advantage of another’s mental state or her knowledge of another’s personal weaknesses to impair free will and induce the formation of an unfair agreement. Lack of sophistication is an example of a situation where one party may end up proving she was unduly influenced by another.

What is the defense of force majeure?

The defense of force majeure releases a party from obligation or liability when a circumstance beyond control occurs preventing performance of the agreement. Some examples include war, riot, crime, or strike, as well as any event considered an “act of God,” such as an earthquake, hurricane, tornado, flooding, or volcanic eruption.

Prior to becoming President, Donald Trump effectively used “force majeure” – alleging that the Great Recession and the financial collapse of 2008 was an unexpected “force majeure,” or act of God, that negated his duties to repay Deutsche Bank the $40 million dollars he personally guaranteed to build Trump International Hotel & Tower in Chicago.  The two sides ended up settling on an agreement in 2010 that gave Trump a five-year extension on paying the money back.  A copy of the lawsuit can be viewed by clicking here: TrumpComplaint v Deutsche Bank & Fortress.

What is the defense of impossibility?

Performance of a valid guarantee agreement is excused where facts that a party did not cause, and could not reasonably have anticipated, intervene to make performance objectively impossible. Objective impossibility is where such an event has made performance impossible by anyone. Subjective impossibility is where performance is made impossible only for the specific party involved. Courts have held that only objective impossibility discharges the duty to perform. Some examples include where a change in the law or act of government make performance illegal, where the subject matter of the agreement is destroyed by a supervening event, or where a person promising to perform services dies or becomes seriously ill.  An intervening event that makes performance more expensive or difficult, on the other hand, does not amount to impossibility, even if performance becomes unprofitable.

What is the defense of frustration of purpose?

A guarantee agreement may also be discharged where the purpose or value of the agreement has destroyed the value of performance for all parties involved, thus causing a frustration of purpose of the agreement.

If you need help with an SBA debt or have received a Notice of Intent to Initiate Administrative Wage Garnishment proceedings from the Treasury Department’s Bureau of Fiscal Service, contact us today for a free initial case evaluation at 1-888-756-9969.

We can analyze your prospects for an SBA offer in compromise, help neutralize Treasury’s aggressive collection demands and defend you against an Administrative Wage Garnishment before a Hearing Official.

We are here to help you with your SBA loan problems.

Call our experienced attorneys at (888) 303-6975 anytime for a Free Case Evaluation