Are SBA Loan Debts Dischargeable in Chapter 7 Bankruptcy?

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Are SBA Loan Debts Dischargeable in Chapter 7 Bankruptcy?

The short answer to this commonly-asked question is – generally, yes.  But, there are significant risks that SBA business owners, SBA guarantors and SBA obligors should be aware of before making the final decision of filing for a Chapter 7 bankruptcy to discharge an SBA guaranteed loan.

Question:  What significant risks can materialize if an SBA debtor files bankruptcy to discharge an SBA loan debt associated with an SBA Unconditional Guarantee?

Answer:  The most significant risk that can occur is where the SBA 7(a) Lender, Certified Development Corporation (CDC) or the SBA files a Complaint initiating an Adversary Proceeding under 11 U.S.C.A. § 523(a)(2)(B) in response to an SBA debtor’s Chapter 7 bankruptcy filing.

Question: What are the allegations that can accompany a Complaint for an Adversary Proceeding?

Answer:  Generally, the Plaintiff (SBA 7(a) Lender, CDC or the SBA) requests the federal bankruptcy court to find that the SBA loan balance is non-dischargeable because the SBA debtor obtained the SBA loan from the Plaintiff fraudulently by providing it with documented misrepresentations or false financial statements regarding the financial condition of the business or of the personal guarantor(s).

The Plaintiff would generally argue that, as a result of the SBA debtor’s fraud or misrepresentation, it has incurred losses in the outstanding amount of the SBA debt, plus costs, interest, attorneys’ fees, and expenses, for which it seeks a judgment.

Question:  What federal laws govern non-dischargability of eligible debts under a Chapter 7 bankruptcy filing?

Answer: The non-dischargeability of debts is governed by 11 U.S.C.A. § 523, which provides, in

material part:

(a) A discharge under section 727[5] . . . of this title does not discharge an individual debtor from any debt —

(2) for money, property, services, or an extension, renewal, or refinancing of credit, to the extent obtained, by —

…

(B) use of a statement in writing—

(i) that is materially false;

(ii) respecting the debtor’s or an insider’s financial condition;

(iii) on which the creditor to whom the debtor is liable for such money, property, services, or credit reasonably relied; and

(iv) that the debtor caused to be made or published with intent to deceive[.]

…

(c)(1) Except as provided . . ., the debtor shall be discharged from a debt of a kind

specified in paragraph (2) . . . of subsection (a) of this section, unless, on request of the creditor to whom such debt is owed, and after notice and a hearing, the court determines such debt to be excepted from discharge under paragraph (2) . . ., as the case may be, of subsection (a) of this section. 11 U.S.C.A. § 523.

Question:  What kind of proof must the shown against the SBA debtor in order to convince a court to issue an order of non-dischargeability of an SBA debt?

Answer:  In general, a determination of non-dischargeability under § 523(a)(2)(B) requires proof that the Plaintiff (SBA 7(a) Lender, CDC or the SBA) loaned money after it reasonably relied upon false financial documents concerning the SBA debtor and/or an insider, provided to it by the SBA debtor either directly or indirectly, and that the SBA debtor intended to deceive the Plaintiff when doing so.

Question: Does fraudulent behavior expose an SBA debtor to criminal charges as well?

Answer: The kinds of behavior required to have an SBA debt be considered not dischargeable can sometimes result in criminal charges.

Where applicable, an SBA debtor can be charged with grand theft or other related fraud in connection with procuring an SBA guaranteed loan.

Question: What other kind of SBA debtor behavior can result in an SBA debt not being discharged in bankruptcy?

Answer: There are two other main kinds of potentially problematic behavior:

• Fraud in a fiduciary capacity
• Willful and malicious injury

Fraud in a fiduciary capacity can be alleged through fraud, trick and device, with a preconceived design and intent, that an SBA debtor misappropriated monies from the Plaintiff SBA 7(a) Lender, CDC or SBA.

The allegations about injury can center around the SBA debtor’s actions and the claim that they were willful, malicious, and the proximate cause of the financial damages.

Question: Does the bankruptcy court have the power to decide whether a disputed claim re an SBA debt be discharged, and to determine the amount an SBA debtor owes?

Answer: Simply put, yes – a bankruptcy court has this power. 

Although it's clear that Congress has the power to legislate about bankruptcy under the U.S. Constitution, for decades there have been big debates about how much power bankruptcy judges can have under the Constitution.

The situation was complicated a few years ago by an opinion of the U.S Supreme Court that somewhat restricted the power of bankruptcy judges. 

However, the Supreme Court opinion does not apply to non-dischargeability issues, which are firmly within the jurisdiction of the federal bankruptcy courts.

If you are considering filing bankruptcy for an SBA loan debt stemming from an SBA Unconditional Guarantee or a Treasury/Bureau of Fiscal Service debt problem, contact us today for a FREE initial consultation with an experienced SBA or Treasury workout attorney at 1-888-756-9969

We can analyze your SBA loan, Treasury/BFS debt or Private Collection Agency problem and advise you on a range of potential solutions.

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