Misuse or Misapply SBA EIDL Loan Proceeds and Chapter 7 Bankruptcy Filings

 Misuse or Misapply SBA EIDL Loan Proceeds and Chapter 7 Bankruptcy Filings

As many readers of our emails and blogs know, we have developed a practice representing individuals and businesses that have defaulted on SBA loans. We either want to do a workout with the SBA or file for bankruptcy.

The first question we are asked is whether SBA loans are dischargeable in a Chapter 7 bankruptcy filing. The answer to that question is yes. The SBA (depending on the amount of the loan) is either an unsecured or a secured creditor, and those loans are dischargeable in a chapter 7 bankruptcy filing.

The second question we asked is: if the business files for chapter 7 bankruptcy, is the business owner who guaranteed the loan (if the SBA loan was greater than $200,000.00, a guarantee is required) still liable to pay for the defaulted loan? The answer is yes.

The third question is, What happens if the business that received the SBA EIDL loan misuses or misapplies the SBA loan proceeds?

The SBA EIDL loan requires borrowers to use the funds only for eligible expenses like payroll, fixed debts, accounts payable, and other regular business expenses (working capital).

Using funds for unauthorized purposes violates loan terms.

If the SBA determines a borrower misused the funds or did not use them as required, it can demand repayment of the loan. It can also commence litigation against the borrower to collect the monies. The SBA can foreclose against business assets if they are secured or sue the guarantor. The SBA can obtain a judgment, garnish wages, place liens on property, and liquidate assets to recover the unpaid loan balance. The SBA can also refer the defaulted loan to the Treasury Department for further collection efforts.

The fourth question we are asked is: if the business that received the SBA EIDL loan misused or misapplied the SBA loan proceeds, can that entity file for chapter 7 bankruptcy to discharge the loan?

For example, what if the borrower did not use the money for working capital or operating expenses but instead used the money for personal expenses such as the purchase of real estate, an automobile, or a stock or bond investment?

The misuse or misapplication of the SBA EIDL loan proceeds may prevent the borrower from receiving a discharge in bankruptcy for the reasons provided below.

First, the dischargeability of SBA EIDL loans in Chapter 7 Bankruptcy is governed by bankruptcy law under 11 U.S.C.  § 523(a)(2)(B).

Section 523(a)(2)(B) pertains to the non-dischargeability of debts arising from "false pretenses, false representation, or actual fraud, other than a statement respecting the debtor's financial condition. 

If the SBA determines that the borrower engaged in fraud, the SBA could commence an adversary proceeding objecting to the business’s bankruptcy discharge (an adversary proceeding is litigation commenced by a party after a bankruptcy filing).

COMMENTS:

1. Adversary proceedings in Bankruptcy are expensive and time-consuming, and creditors do not frequently commence litigation in bankruptcy cases, in this author’s experience.

2. Will the chapter 7 Bankruptcy Trustee inquire about the misuse or misapplication of funds and notify the SBA? Generally, that is not the concern of a Bankruptcy trustee.

3. The larger the loan amount, the more likely the SBA will object to the discharge.

4. If there is a guarantee, the SBA will be less likely to commence litigation.

5. The SBA employees are busy, and they may just write off the loan and move on to the next case.

6. We were unable to find any Bankruptcy cases involving the misuse or misapplying of SBA EIDL loan proceeds or adversary proceedings by the SBA (although those cases may exist).

7. If the SBA commences litigation, they need to prove fraud (which is difficult), and there may be opportunities to settle the case.

8. Finally, the Debtor needs to do a cost-benefit analysis regarding the cost of the chapter 7 bankruptcy filing and the risk of an adversary proceeding being commenced by the SBA.

Businesses or creditors with questions about the misuse or misapplying of SBA EIDL loans should contact Jim Shenwick, Esq., at 917-363-3391  jshenwick@gmail.com

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Other Posts by James Shenwick, Esq. regarding SBA EIDL Loans

SBA EIDL HARDSHIP PROGRAM

https://shenwick.blogspot.com/2023/07/sba-eidl-hardship-program.html

Defaulted SBA EIDL Loans, Limited Liability Company (LLC) and Cancellation of Debt Income (COD) under Section 108 of the Internal Revenue Code

https://shenwick.blogspot.com/2023/07/defaulted-sba-eidl-loans-limited.html

Offers In Compromise ("OIC") for Defaulted SBA EIDL loans and Section 108 of the Internal Revenue Code ("IRC"), Relief of Indebted Income, a Trap for the Unwary!

https://shenwick.blogspot.com/2023/05/offers-in-compromise-oic-for-defaulted.html

EIDL LOAN WORKOUTS AND BANKRUPTCY    https://shenwick.blogspot.com/2022/07/eidl-loan-workouts-and-bankruptcy.html

EIDL Loan Default Questions & Answers

https://shenwick.blogspot.com/2022/10/eidl-loan-default-questions-answers.html

EIDL LOAN DEFAULT DOCUMENT REVIEW, WORKOUT, BANKRUPTCY FILING & OFFER IN COMPROMISE

https://shenwick.blogspot.com/2022/07/eidl-loan-default-document-review.html

EIDL Defaulted Loans

https://shenwick.blogspot.com/2022/07/eidl-defaulted-loans.html

New Relief Program for SBA EIDL Borrowers Who are Having Difficulty Repaying EIDL Loans " Hardship Accommodation Plan"

https://shenwick.blogspot.com/2023/05/new-relief-program-for-sba-eidl.html

EIDL LOANS and SBA OFFER IN COMPROMISE PROGRAM

https://shenwick.blogspot.com/2022/07/eidl-loans-and-sba-offer-in-compromise.html

PPP & EIDL Fraud

https://shenwick.blogspot.com/2022/08/ppp-eidl-fraud.html

Better to connect-What small business owners need to know about repaying loans tied to pandemic relief from the SBA EIDL Loans

https://shenwick.blogspot.com/2022/11/better-to-connect-what-small-business.html