SBA Loan Default: The Equitable Estoppel Defense
For federally-backed SBA loans (SBA 7(A) or SBA 504) which are offered to Small Business Borrowers, the Lender of Record or Certified Development Corporation (CDC) usually demands that the small business owners sign a personal guaranty or pledge additional collateral such as requesting that the small business owners and their spouses sign a deed of trust or mortgage resulting in a lien being recorded on the small business owners’ personal residence.
In certain instances, for example, the Lender of Record or CDC, through its representatives tell the small business owner that the SBA loan will not close without an executed personal guarantee or a recorded lien on the owner’s home. We have heard stories where lenders make certain representations to the small business owners and their spouses that after a certain number of consecutive payments on the loan (e.g., 12-36 monthly payments), the lender would then release or remove the recorded lien on the pledged home. In almost all cases where these promises were made in order to close the SBA-backed loan, the lender’s promise to release the lien on the home before maturation of the SBA-backed loan, was a complete falsehood. However, the end result is that the small business owner has not only pledged the business’s collateral for the loan, signed a personal guarantee, but also has allowed a lien on his or her family residence with the latter pledge happening only because of the lender employee’s false promise. If an SBA loan default happens to occur, then the lender (including its assignees such as the SBA) now has superior leverage over the small business owner because of the recorded lien on the home – which is now subject to a foreclosure or other action pursuant to a collateral liquidation plan.
If faced with this problem, folks who have pledged their home as additional collateral based on a lender’s fraudulent representation that that lien would only be temporary, should consider exploring defenses and remedies such as “equitable estoppel.”
Requirements of General Estoppel Defense
A party can present a defense of estoppel if he or she shows a misrepresentation of a material fact upon which the party asserting estoppel detrimentally relied. The elements of equitable estoppel are: (1) representation as to a material fact that is contrary to a later-asserted position; (2) reliance on that representation; and (3) a change in position detrimental to the party claiming estoppel that is caused by the representation and reliance thereon. The doctrine of equitable estoppel precludes a person from maintaining inconsistent positions to the detriment of another.
Equitable estoppel is based on principles of fair play and essential justice and arises when one party lures another party into a disadvantageous legal position. Equitable estoppel is the effect of the voluntary conduct of a party whereby he or she is absolutely precluded, both at law and in equity, from asserting rights which perhaps have otherwise existed, either of property, contract, or remedy, as against another person who has in good faith relied upon such conduct and has been led thereby to change his or her position for the worse and who on his or her part acquires some corresponding right, either of property, contract, or remedy. Simply put, equitable estoppel is generally words or conduct which cause another person to believe a certain state of things exists and to consequently change his or her position in an adverse way.
Generally speaking, equitable estoppel operates as a shield, not as a sword, and operates against the wrongdoer, not the victim. It is designed to prevent a loss rather than help a litigant in gaining something. The prime purpose of the doctrine of equitable estoppel is to prevent a party from profiting from his or her wrongdoing. Therefore, where the words or conduct of one party causes another to forbear to his or her detriment, equitable estoppel could be argued and applied to prevent harm to the innocent party.
In order to assert a defense of estoppel, it is generally necessary that the representations, whether consisting of words, acts, omissions, or conduct of the party against whom the estoppel is being asserted, were believed by the party claiming the estoppel. The party asserting equitable estoppel must prove that he or she reasonably relied on the conduct of the other party.
Equitable estoppel rests largely upon injury or prejudice to the rights of the party who asserts it. Because the function and purpose of the doctrine of estoppel is the prevention of fraud and injustice, there can be no estoppel where there is no loss, injury, prejudice, or detriment to the party claiming it. Hence, the defense of estoppel by fraud and deceit is not proper where the evidence establishes no detrimental change in position by the party claiming the fraud and deceit.
In summary, the general elements of equitable estoppel in the SBA-backed loan context with a personal residence pledged as additional collateral based on a misrepresentation of the lender are:
- the lender or its agent must have made a representation to the small business owner that the lien being placed on the home will be released prior to the maturity of the loan as part of the lender’s objective to induce the small business owner to pledge his or her home so as to close the loan transaction;
- this representation must have led the small business owner to believe that the lien will only be temporary and will be released after a certain number of successful payments prior to maturity;
- the small business owner (including his or her spouse) must have relied upon the representation to their detriment;
- this reliance must have been reasonable, and foreseeable to the lender.
When these elements are present, equitable estoppel could be used as a defense to a foreclosure action or as leverage for resolving an SBA loan problem.
If you are facing an SBA loan default, contact us today for a FREE initial consultation with an experienced SBA workout attorney at 888-756-9969
We analyze your SBA loan problems and advise you on potential solutions such as an SBA offer in compromise for your SBA loan default.