Millions of small company owners who received a loan through the Economic Injury Catastrophe Loan (EIDL) program were alleviated to get authorized for among these low-rate loans through the Small company Administration (SBA). But some smart borrowers who carefully reviewed their loan contracts have balked at what seems difficult arrangements enforced on customers, including confusing and contradictory language about individual guarantees.
The EIDL loan arrangement (which you can read completely here) currently states:
“By signing or otherwise verifying below, each individual and each company becomes collectively and severally obliged as a Customer under this Agreement.”
“The terms are really uncomplicated and clear: This is an individual assurance,” observes small company lawyer Garrett Sutton, and my co-author of Finance Your Own Organisation: Get on the Financing Fast Lane. He adds, “As well, the note defines a ‘Guarantor’ as implying ‘Each person or entity that signs an assurance of payment for this note.'”
This regardless of the fact that The CARES Act waived the personal warranty for smaller sized loans with the following language:
“With respect to a loan made under area 7( b)( 2) of the Small Service Act (15 U.S.C. 636( b)( 2 )) in reaction to COVID-19 throughout the covered duration, the Administrator will waive–
“( 1) any rules related to the personal guarantee on advances and loans of not more than $200,000 during the covered duration for all candidates; …”
Sutton states that the waiver of the individual assurance for loans listed below $200,000 should be shown in the contract. “If the federal government were on top of it they would alter the document,” says Sutton. He recommends debtors include their own addendum which notes that because the loan is below $200,000, this does not include a personal warranty. (Caution: That does not appear to be possible to do with the platform the SBA is utilizing.)
“The government might not implement it, however the method it’s written they could,” he cautions.
The borrower who called me about this language likewise raised this question with the SBA and got the following email from an SBA worker:
“I got your query requesting clarification on specific terms in the Loan Authorization and Contract. It is necessary to note when reading the contract, that the terms use just to the Customer, recognized in this particular Arrangement as the [Company Name] and not the Officer Call. The note, Security Arrangement, Loan Authorization Arrangement terms all must be checked out with respect to business or company acknowledging and accepting the terms, and not any people for loans under $200,000.
“The individual designated to sign on behalf of business indications the files only as ‘Owner/ Officer’ of the company, and not ‘Individually.’ There must be someone to sign on behalf of the entity …
“For all loans above $200,000, there is a different Assurance document prepared where the principal of the organization check-in their Specific Capability and there is an extra Assurance Paragraph in the Loan Permission and Arrangement. Those are not present in the loans under $200,000.
“While the Arrangement does not state that no individuals are personally liable on the loan, The Loan Permission and Arrangement specifically mentions each specific or entity acknowledges and accepts personal commitment and complete liability under the Note as a customer. Once again, the last 2 words of that sentence are important, as it is just The Customer (business) on loans under $200,000 who are accountable under the loan and agree to the terms in the Arrangement.
“The Security Contract just grants a security interest in the residential or commercial property owned by Debtor (Company), and the UCC financing declaration to be filed will just recognize the Business as the debtor, without any recommendation to the officer finalizing on behalf of the business.”
But what about the fact that EIDL loans are readily available to independent contractors and the self-employed who may have no official legal structure separating their individual financial resources from their businesses? (In reality, according to the SBA, in 2012 simply under 20% of small services operated as corporations.) This reaction seems to imply there is always a legal separation between the business and the individual, which we understand just is not the case.
More contact details
This issue over the individual warranty language in the EIDL agreement may look like splitting hairs, but it illustrates how essential it is to check out bank loan agreements prior to you sign them. It’s not always easy or satisfying, but it is important. Not a legal expert? Most of us aren’t. So when you’re devoting your organization or yourself to pay back countless dollars, it’s an excellent concept to have a little organization lawyer who can assist you examine the contract.
Continuing our example of why that’s so critical, here are a couple of additional factors to consider you can learn from examining an EIDL contract:
Lenders often require security for little business loans. And SBA loans normally need collateral, though that requirement has been waived for smaller sized EIDL loans related to COVID-19. The EIDL arrangement requires any borrower accepting a loan of more than $25,000 to pledge a comprehensive list of security:
“For loan quantities of higher than $25,000, Debtor hereby grants to SBA, the protected party hereunder, a continuing security interest in and to any and all ‘Security’ as described herein to protect payment and performance of all financial obligations, liabilities, and obligations of Debtor to SBA hereunder without constraint, including however not limited to all interest, other costs and expenditures (all hereinafter called ‘Commitments’). The Collateral includes the following home that Customer now owns or shall get or produce instantly upon the acquisition or production thereof: all concrete and intangible personal effects, including, but not restricted to: (a) stock, (b) equipment, (c) instruments, consisting of promissory notes (d) chattel paper, consisting of concrete belongings paper and electronic effects paper, (e) documents, (f) letter of credit rights, (g) accounts, consisting of health-care insurance receivables and credit card receivables, (h) deposit accounts, (i) commercial tort claims, (j) general intangibles, consisting of payment intangibles and software application and (k) as-extracted security as such terms might from time to time be specified in the Uniform Commercial Code. The security interest Borrower grants include all accessions, accessories, devices, parts, materials, and replacements for the Collateral, all products, proceeds, and collections thereof and all records and information relating thereto.”
It also goes on to state:
“Customer will not offer or move any collateral (except regular stock turnover in the normal course of service) described in the ‘Collateral’ paragraph hereof without the previous written approval of SBA.”
Some loan providers need borrowers to carry essential individual life insurance or other kinds of insurance to safeguard the lending institution. In the case of EIDL, the SBA needs the customer to preserve hazard insurance to protect security:
“Within 12 months from the date of this Loan Permission and Contract the Borrower will provide proof of an active and in result risk insurance coverage consisting of fire, lightning, and extended coverage on all products utilized to protect this loan to a minimum of 80% of the insurable value. The borrower will not cancel such coverage and will preserve such coverage throughout the whole regard to this Loan.”
Probably this requirement won’t use in all cases, such as smaller loans or loans where there is no physical collateral promised. Nonetheless, it’s an important requirement that the company owner needs to understand.
Distribution of properties
By signing the EIDL loan agreement the customer needs the customer to agree not to disperse assets:
“Borrower will not, without the previous written permission of SBA, make any circulation of Borrower’s assets, or provide any favoritism, make any advance, straight or indirectly, by a method of loan, present, bonus offer, or otherwise, to any owner or partner or any of its workers, or to any company straight or indirectly controlling or affiliated with or controlled by Borrower, or any other business.”
What if you can’t pay it back?
Offered the uncertainty of today’s company environment, it’s not surprising customers are concerned about what occurs if they can not repay their SBA EIDL loans. The EIDL loan agreement states:
“SBA’S RIGHTS IF THERE IS A DEFAULT: Without notice or need and without quitting any of its rights, SBA may: A) Need instant payment of all amounts owing under this Note; B) Draw on gathering all amounts owing from any Customer or Guarantor (if any); C) File match and obtain judgment; D) Take possession of any Security; or E) Sell, rent, or otherwise deal with, any Collateral at public or private sale, with or without advertisement.”
Defaulting on a federal loan is constantly a major matter as the federal government has extra collection powers private lenders do not. Even if the personal warranty safeguards customers, defaulting may avoid a customer from getting approved for other federal loans such as federal trainee loans.
Before you sign a loan agreement
None of this is meant to recommend borrowers should avoid these loans. In the present loaning environment where inexpensive unsecured loans can be hard to get, these loans will no doubt save some services. However, remember that the SBA is doing what it can to protect the lending institution– which in this case is the U.S. government.
Your job is to secure your company. This indicates reviewing and understanding loan arrangements prior to you sign so you can make an informed decision.