When is an SBA Guarantee Legally Unenforceable
Book a Consultation CallObtaining commercial financing is one of the most difficult challenges facing small businesses. Many small businesses turn to SBA loan programs to finance their businesses.
Without adequate sources of collateral, the participating SBA lender and the SBA always require a personal guarantee before it agrees to approve a loan to the small business. While SBA lenders, banks, financing companies, or other SBA loan underwriters attempt to collect on a personal guarantee, there are certain circumstances where the SBA personal guarantee agreement may be legally unenforceable.
An SBA personal guarantee is a promise to pay a debt for another –which is usually the small business borrower. The SBA personal guarantor is the person making the promise – who is usually a member or shareholder of the small business borrower seeking the SBA loan. SBA Standard Operating Procedures (SOPs) state that participating SBA lenders are required to obtain the personal guarantees of individuals owning at least 20% of a small business’s interest or shares.
When you sign an SBA personal guarantee on behalf of an eligible small business, you agree to be personally responsible for repaying that SBA debt in the event the small business later becomes insolvent. For example: your small business manufactures and sells widgets, and it needs commercial equipment to do so. You go to an SBA lender and obtain financing for the commercial equipment, and part of the financing agreement contains an SBA personal guarantee. Sometime later, due to unexpected circumstances, your small business customers suddenly no longer need your widgets, and your small business fails as a result. If the SBA lender cannot recover the balance of its loan from the assets of your small business, it will then consider suing you personally for the remaining balance pursuant to the SBA personal guarantee you signed.
In other words, when you sign an SBA personal guarantee in order for your small business to receive a loan, you pledge your personal assets as collateral, including your home, the cash in your personal checking account, your savings and investments, and your future wages, which the SBA lender or SBA can try to seize.
SBA personal guarantees are a critical aspect of many SBA loan transactions, so entrepreneurs and small business owners should familiarize themselves with the potential consequences of signing one. In general, to be enforceable, SBA personal guarantee must meet certain criteria.
An SBA personal guarantee must be in writing and it must be signed by the SBA guarantor in the SBA guarantor’s personal capacity.
While this may be obvious, this cannot be overlooked. To be legally enforceable, the signatory to the SBA personal guarantee agreement must sign in his or her personal capacity and not as the “President” or “CEO” of the small business receiving the loan, which is its own legal entity, separate and apart from the people that run and operate it.
An SBA personal guarantee is not legally enforceable without consideration
In fact, no contract is legally enforceable without consideration. An SBA personal guarantee is a type of contract. A contract is an enforceable promise. The legal enforceability of a contract comes from one party’s giving of “consideration” to the other party. Here, the SBA lender gives an SBA-guaranteed loan (the consideration) in exchange for the SBA personal guarantor’s promise to repay it. In a lawsuit to collect a debt, the SBA lender must prove that it has the right to collect the debt, i.e., that it gave the loan (i.e., the consideration) to the debtor. Sometimes, the parties to an SBA loan transaction cannot produce documents showing a right to collect; this may be attributable, at least in part, to the number of times that SBA loans are resold on the secondary market or assigned to other counterparties.
An SBA personal guarantee may be legally unenforceable if it was obtained under fraudulent circumstances or it violates federal law or public policy.
Under certain circumstances, an SBA personal guarantee may be found to legally unenforceable if, for example, it was required from a business owner’s spouse who was not an owner, shareholder, officer or employee of the small business. Obtaining a spousal guarantee under certain circumstances may violate the Equal Credit Opportunity Act (ECOA) and could render the SBA personal guarantee signed by the spouse void.
Can an SBA personal guarantee be revoked?
An otherwise valid and legally enforceable SBA personal guarantee can be revoked in several different ways. An SBA personal guarantee much like any other contract, can be revoked if both the SBA guarantor and the SBA lender agree (with the SBA’s approval) in writing. Some debts owed by SBA personal guarantors can also be discharged in bankruptcy or declared invalid pursuant to court order through litigation.
Many factors can affect the legal enforceability of SBA personal guarantees. If you have any questions about the legal enforceability of an SBA personal guarantee that you are about to sign or have already signed, consult with one of our experienced SBA debt attorneys who can assess your situation and offer thoughtful and practical guidance to assist in your decision.
Contact us today to set up an appointment to discuss your SBA loan issues and problems.
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Client personally guaranteed SBA 7(a) loan balance of over $150,000. Business failed and eventually shut down. SBA then pursued client for the balance. We intervened and was able to present an SBA OIC that was accepted for $30,000.
Client’s small business obtained an SBA 7(a) loan for $150,000. He and his wife signed personal guarantees and pledged their home as collateral. The SBA loan went into default, the term or maturity date was accelerated and demand for payment of the entire amount claimed was made. The SBA lender’s note gave it the right to adjust the default interest rate from 7.25% to 18% per annum. The business filed for Chapter 11 bankruptcy but was dismissed after 3 years due to its inability to continue with payments under the plan. Clients wanted to file for Chapter 7 bankruptcy, which would have been a mistake as their home had significant equity to repay the SBA loan balance in full as the Trustee would likely seize and sell the home to repay the secured and unsecured creditors. However, the SBA lender opted to pursue the SBA 7(a) Guaranty and subsequently assigned the loan and the right to enforce collection to the SBA. Clients then received the SBA Official 60-Day Notice and hired the Firm to respond to it and negotiate on their behalf. Clients disputed the SBA’s alleged balance of $148,000, as several payments made to the SBA lender during the Chapter 11 reorganization were not accounted for. To challenge the SBA’s claimed debt balance, the Firm Attorneys initiated expedited discovery to obtain government records. SBA records disclosed the true amount owed was about $97,000. Moreover, because the Clients’ home had significant equity, they were not eligible for an Offer in Compromise or an immediate Release of Lien for Consideration, despite being incorrectly advised by non-attorney consulting companies that they were. Instead, our Firm Attorneys recommended a Workout of $97,000 spread over a lengthy term and a waiver of the applicable interest rate making the monthly payment affordable. After back and forth negotiations, SBA approved the Workout proposal, thereby saving the home from imminent foreclosure and reducing the Clients' liability by nearly $81,000 in incorrect principal balance, accrued interest, and statutory collection fees.
Clients personally guaranteed SBA 504 loan balance of $750,000. Clients also pledged the business’s equipment/inventory and their home as additional collateral. Clients had agreed to a voluntary sale of their home to pay down the balance. We intervened and rejected the proposed home sale. Instead, we negotiated an acceptable term repayment agreement and release of lien on the home.
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