EIDL Alert: Why You Should Read the Fine Print in Small Business Contracts
On December 22, 2020, Congress passed the Stimulus Bill that includes new EIDL grants, new Paycheck Protection Program loans, and other small business support. Learn more about this legislation and apply for a new PPP loan here.
Millions of small business owners who received a loan under the Economic Disaster Lending Program (EIDL) were relieved to get approval for one of these low rate loans through the Small Business Administration (SBA). But some savvy borrowers who have carefully reviewed their loan agreements have balked at what appear to be onerous terms imposed on borrowers, including confusing and contradictory language about personal guarantees.
The EIDL loan agreement (which you can read in full here) currently indicates:
“By signing or otherwise authenticating below, each individual and organization becomes jointly and severally liable as a Borrower under this Agreement. “
“The terms are very simple and clear: this is a personal guarantee,” observes small business lawyer Garrett Sutton, and my co-author of Finance your own business: get started on the finance fast lane. “In addition, the note defines a ‘guarantor’ to mean ‘each person or entity that signs a payment guarantee for that note’,” he adds.
This despite the fact that The CARES law waived the personal guarantee for small loans with the following language:
With respect to a loan made under Section 7 (b) (2) of the Small Business Act (15 USC 636 (b) (2)) in response to COVID-19 during the Covered Period, the Administrator must waive To :
(1) any rule relating to the personal guarantee on advances and loans of up to $ 200,000 during the period covered for all applicants;
Sutton says the waiver of the personal guarantee for loans under $ 200,000 should be reflected in the contract. “If the government was on top, it would change the document,” Sutton says. He recommends borrowers add their own addendum stating that since the loan is less than $ 200,000, it does not include a personal guarantee. (Warning: this does not seem possible with the platform used by the SBA.) “The government may not enforce it, but as it is written it could,” he warns.
The borrower who contacted me about this language also raised this issue with the SBA and received the following email from an SBA employee:
I have received your request for clarification on certain terms of the authorization and the loan agreement. It is important to note when reading the agreement, that the terms only apply to Borrower, identified in this specific agreement as the [Company Name] and not the officer’s name. The note, the guarantee agreement, the terms of the loan authorization agreement should all be read in relation to the company or organization that recognizes and accepts the terms, and not to individuals for the loans less than $ 200,000.
The person designated to sign on behalf of the company signs documents only as “Owner / Director” of the organization, not “Individually”. There must be someone to sign on behalf of the entity …
For all loans over $ 200,000, a separate guarantee document is prepared in which the director of the organization individually signs and there is an additional guarantee paragraph in the loan authorization and agreement. These are not present in loans under $ 200,000.
While the agreement does not state that no natural person is personally responsible for the loan, the loan authorization and agreement specifically states that each person or entity recognizes and accepts personal obligation and full responsibility in under the note. as a borrower. Again, the last two words of this sentence are important, as only the borrower (company) for loans under $ 200,000 is responsible for the loan and accepts the terms of the agreement.
The guarantee agreement only grants security on the property held by the borrower (company), and the UCC financing statement to be filed will only identify the company as the debtor, without reference to the signing officer on the Company Name.
But what about the fact that EIDL loans are available to independent entrepreneurs and self-employed people who may not have a formal legal structure separating their personal finances from their businesses? (In reality, according to SBA, in 2012, just under 20% of small businesses operated as corporations.) This answer seems to imply that there is still a legal separation between business and individual, which we know is not just not the case.
More details on the contract
This question about the language of the personal guarantee in the EIDL contract may seem like a hairstyle, but it illustrates how important it is to read. small business loan contracts before signing them. It is not always easy or pleasant, but it is vital. Are you not a lawyer? Most of us are not. So, when you are hiring yourself or your business to pay back thousands of dollars, it’s a good idea to have a small business lawyer who can help you review it.
To illustrate why this is so important, here are some additional considerations you can take from reviewing an EIDL contract:
Lenders often require collateral for small business loans. And SBA loans generally require collateral, although this requirement has been waived for small EIDL loans linked to COVID-19. The EIDL agreement requires any borrower accepting a loan over $ 25,000 to pledge a long list of collateral:
For loan amounts in excess of $ 25,000, the Borrower hereby grants to SBA, the party secured hereunder, continued security in and over all “guarantees” as described herein to secure payment. and performance of all debts, liabilities and obligations of the Borrower to SBA below, without limitation, including, but not limited to, all interest, other charges and expenses (all hereinafter referred to as ” Obligations “). The Guarantee includes the following property which the Borrower now owns or is expected to acquire or create immediately after its acquisition or creation: all tangible and intangible personal property, including, but not limited to: (a) inventory, (b) equipment, (c) (h) deposit accounts, (i) commercial tort claims, (j) general intangibles, including payment intangibles and software, and (k) guarantees extracts as such terms may be defined from time to time in the Uniform Commercial Code. The security given by the Borrower includes all acquisitions, attachments, accessories, parts, supplies and replacements of the Guarantee, all products, products and collections thereof and all records and data relating thereto.
He also adds: “The Borrower will not sell or transfer any collateral (other than normal inventory turnover in the ordinary course of business) described in the“ Guarantee ”section hereof without the prior written consent of the SBA. “
Some lenders require borrowers key person life insurance or other forms of insurance to protect the lender. In the case of EIDL, the SBA requires the borrower to purchase risk insurance to protect the collateral:
Within 12 months from the date of this Loan Authorization and Agreement, the Borrower will provide proof of an active and in force risk insurance policy including fire, lightning and extensive coverage on all items used to secure this loan at at least 80% of the insurable value. value. The Borrower will not cancel this coverage and will maintain this coverage throughout the term of this Loan.
Presumably, this requirement will not apply in all cases, such as smaller loans or loans for which no physical collateral is pledged. Nonetheless, this is an important requirement that business owners should be aware of.
By signing the EIDL loan agreement, the borrower requires the borrower to undertake not to distribute assets:
The Borrower shall not, without the prior written consent of SBA, make any distribution of the assets of the Borrower, nor any preferential treatment, advance, directly or indirectly, in the form of a loan, gift, bonus or otherwise. , to an owner or partner or to one of its employees, or to any company directly or indirectly controlling or affiliated with or controlled by the Borrower, or any other company.
What if you can’t pay it back?
Given the uncertainty of the current business environment, it’s no surprise that borrowers are worried about what will happen if they can’t repay their SBA EIDL loans. The EIDL loan agreement stipulates:
RIGHTS OF SBA ON DEFAULT: Without notice or request and without waiving any of its rights, SBA may: A) Demand immediate payment of all amounts due under this Note; B) Have recourse to collect all amounts owed by any Borrower or Guarantor (if any); C) sue and obtain judgment; D) Take possession of any Guarantee; or E) Sell, rent or otherwise dispose of any collateral at a public or private sale, with or without advertising.
Defaulting on a federal loan is always a serious matter, as the government has additional collection powers that private creditors do not have. Even though the personal guarantee protects borrowers, default can prevent a borrower from qualifying for other federal loans such as federal student loans.
Before signing a loan contract
None of this is intended to suggest borrowers to avoid these loans at all costs. In today’s lending environment where low cost unsecured loans can be difficult to obtain, these loans will undoubtedly save some businesses. But remember, the Small Business Administration (SBA) is doing what it can to protect the lender, which in this case is the US government. Your job is to protect your business. And that means reviewing and understanding loan agreements before signing so that you can make an informed decision.
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