Considerations When Closing a Small Business with PPP or EIDL Debt

Small businesses have relied on government assistance, including Paycheck Protection Program (“PPP”) loans and Economic Injury Disaster Loans (“EIDL”) to survive the COVID-19 pandemic’s economic fallout; however, even with such help, many small businesses are facing the prospect of closing their doors with outstanding government loans and other obligations.  This blog points out certain considerations that small business owners and their advisors should be cognizant of when shuttering businesses with open PPP loans, including reputational impact and risk to federally held assets.

The Coronavirus Aid, Relief, and Economic Stimulus (“CARES”) Act legislation passed by Congress in March of 2020 provided small businesses impacted by the global pandemic with hundreds of billions of dollars in forgivable and low interest grants and loans administered by the Small Business Administration (“SBA”) designed to help them weather the upheaval.  By some estimates, however, up to 25% of small U.S. businesses still will not survive.

Certain entities facing ongoing financial hardship will chose to seek Chapter 11 or other bankruptcy protection, and while PPP loan and Coronavirus-related EIDL generally are forgivable, exactly how such loan default will be treated through reorganization is the subject of much current litigation and has yet to be fully determined.

Some small businesses debtors will close without reorganizing and before having received forgiveness for or paying off the funds they received through the PPP loan and/or EIDL programs.  There is still significant uncertainty as to what the consequences will be for these businesses and their owners and affiliates that default on their EIDL and PPP loans due to business closure.  We do know, however, that PPP loan and EIDL default will have some impact and that the impact will be primarily related to the size of the outstanding government loan(s).

Small Loan Default

PPP loans and EIDL of $25,000 or less do not require collateral or personal guarantees, so in the vast majority of defaults on these small loans, business owners’ personal assets will not be at risk of seizure.  Additionally, large percentages of these loans are forgivable.  Small PPP loan and EIDL default, thus, are fairly low risk for borrowers.  But there are concerns of which these businesses should be aware.  The biggest considerations for small businesses defaulting on small PPP loans are (1) reputational and (2) impact on federally held assets.

When a business defaults on a loan with the federal government, the government “lender” may report the business to credit scoring companies.  This could result in a negative impact to the credit scores of business and/or individual affiliated entities, including the small business owner, making obtaining future credit harder and more expensive.

Additionally, if the defaulting business has any federally held assets, including pending income tax refunds, those assets could be seized by the federal government lender in the event of default.

Larger Loan Default

PPP loans and EIDL of greater than $25,000 carry significantly greater risk to the defaulting small business and its owners and affiliates.  This risk may be of particular concern with respect to EIDL, which generally provide less forgiveness than PPP loans and thus are more likely to remain active debt at the time a small business needs to close.  The degree of risk largely depends upon the individual loan terms and, in particular, whether the loan is collateralized and/or required personal guarantees.

Most EIDL between $25,000 and $200,000, for example, do require collateral but generally do not require personal guarantees; in this case, collateral such as inventory or manufacturing equipment could be seized to satisfy or partly satisfy outstanding debt of the borrower but personal assets of the business owner such as her home and vehicle generally are safe from seizure.

Most loans of greater than $200,000 are both collateralized and require personal guarantees; in such cases, bankruptcy generally would be a preferable option for the guarantor who stands to lose their personal assets when the SBA comes knocking.

Stay Tuned

The SBA has yet to provide small business debtors and their advisors with comprehensive guidance on how PPP loan and Coronavirus-related EIDL debt will be treated in bankruptcy and where reorganization is not sought but the debtor must close its doors.  It has suggested that it will use its significant enforcement reach to protect government funds loaned and not forgiven through the EIDL and PPP programs.  Political and policy considerations surrounding the COVID-19 crisis, however, may influence how such saber rattling actually materializes in reality for failing small businesses.

All small businesses should endeavor to seek and complete all possible PPP loan and EIDL forgiveness prior to reorganizing or closing to minimize the debt at issue.  Forgiveness is the cleanest and easiest route to avoid the trappings of loan default.  In the event of default, businesses with loans of less than $25,000 should be aware of potential reputational and federal asset impacts but can be fairly confident that additional risk is minimal.  Borrowers of higher amounts should carefully consider and understand their loan terms, particularly with respect to collateral and guarantees, prior to taking action to close their business and default on their PPP loan and EIDL debt.