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On December 22, 2020 Congress passed the stimulus bill which includes new EIDL grants, new Paycheck Protection Program loans and other small business relief. Read more about that legislation and apply for a new PPP loan here.

Millions of small business owners who received a loan through the Economic Injury Disaster Loan (EIDL) program were relieved to get approved for one of these low-rate loans through the Small Business Administration (SBA). But some savvy borrowers who carefully reviewed their loan agreements have balked at what appear to be onerous provisions imposed on borrowers including confusing and contradictory language about personal guarantees. 

The EIDL loan agreement (which you can read in full here) currently states: 

“By signing or otherwise authenticating below, each individual and each organization becomes jointly and severally obligated as a Borrower under this Agreement.”

“The terms are very straightforward and clear: This is a personal guarantee,” observes small business attorney Garrett Sutton, and my coauthor of Finance Your Own Business: Get on the Financing Fast Track. “As well, the note defines a ‘Guarantor’ as meaning ‘Each person or entity that signs a guarantee of payment for this note,’” he adds.

This despite the fact that The CARES Act waived the personal guarantee for smaller loans with the following language: 

With respect to a loan made under section 7(b)(2) of the Small Business Act (15 U.S.C. 636(b)(2)) in response to COVID–19 during the covered period, the Administrator shall waive—

(1) any rules related the personal guarantee on advances and loans of not more than $200,000 during the covered period for all applicants;

Sutton says that the waiver of the personal guarantee for loans below $200,000 should be reflected in the contract. “If the government were on top of it they would change the document,” says Sutton. He recommends borrowers add their own addendum that notes that because the loan is below $200,000 this does not include a personal guarantee. (Caveat: That doesn’t appear to be possible to do with the platform the SBA is using.) “The government may not enforce it but the way it’s written they could,” he warns. 

The borrower who contacted me about this language also raised this question with the SBA and received the following email from an SBA employee: 

I received your inquiry requesting clarification on certain terms in the Loan Authorization and Agreement.  It’s important to note when reading the agreement, that the terms apply only to the Borrower, identified in this specific Agreement as the [Company Name] and not the Officer Name.  The note, Security Agreement, Loan Authorization Agreement terms all must be read with respect to the business or organization acknowledging and accepting the terms, and not any individuals for loans under $200,000. 

 The person designated to sign on behalf of the business signs the documents only as “Owner / Officer” of the organization, and not “Individually.” There must be someone to sign on behalf of the entity…

For all loans above $200,000, there is a separate Guarantee document prepared where the principal of the organization signs in their Individual Capacity and there is an additional Guarantee Paragraph in the Loan Authorization and Agreement. Those are not present in the loans under $200,000.

While the Agreement does not state that no individuals are personally liable on the loan, The Loan Authorization and Agreement specifically states each individual or entity acknowledges and accepts personal obligation and full liability under the Note as borrower. Again, the last two words of that sentence are important, as it is only The Borrower (company) on loans under $200,000 who are liable under the loan and agreeing to the terms in the Agreement.

The Security Agreement only grants a security interest in the property owned by Borrower (Company), and the UCC financing statement to be filed will only identify the Company as the debtor, with no reference to the officer signing on behalf of the company.

But what about the fact that EIDL loans are available to independent contractors and the self-employed who may have no formal legal structure separating their personal finances from their businesses? (In fact, according to SBA, in 2012 just under 20% of small businesses operated as corporations.) This response seems to imply that there is always a legal separation between the business and the individual which we know simply is not the case. 

More Contract Details

This issue over the personal guarantee language in the EIDL contract may seem like splitting hairs, but it illustrates how important it is to read small business loan contracts before you sign them. It’s not always easy or enjoyable, but it is vital. Not a legal expert? Most of us aren’t. So when you’re committing your business or yourself to repay thousands of dollars it’s a good idea to have a small business attorney who can help you review it. 

As an example of why that’s so critical, here are a few additional considerations you can learn from reviewing an EIDL contract: 

Collateral

Lenders often require collateral for small business loans. And SBA loans typically require collateral, though that requirement has been waived for smaller EIDL loans related to COVID-19. The EIDL agreement requires any borrower accepting a loan of more than $25,000 to pledge an extensive list of collateral: 

For loan amounts of greater than $25,000, Borrower hereby grants to SBA, the secured party hereunder, a continuing security interest in and to any and all “Collateral” as described herein to secure payment and performance of all debts, liabilities and obligations of Borrower to SBA hereunder without limitation, including but not limited to all interest, other fees and expenses (all hereinafter called “Obligations”). The Collateral includes the following property that Borrower now owns or shall acquire or create immediately upon the acquisition or creation thereof: all tangible and intangible personal property, including, but not limited to: (a) inventory, (b) equipment, (c) instruments, including promissory notes (d) chattel paper, including tangible chattel paper and electronic chattel paper, (e) documents, (f) letter of credit rights, (g) accounts, including health-care insurance receivables and credit card receivables, (h) deposit accounts, (i) commercial tort claims, (j) general intangibles, including payment intangibles and software and (k) as-extracted collateral as such terms may from time to time be defined in the Uniform Commercial Code. The security interest Borrower grants includes all accessions, attachments, accessories, parts, supplies and replacements for the Collateral, all products, proceeds and collections thereof and all records and data relating thereto.

It also goes on to state: “Borrower will not sell or transfer any collateral (except normal inventory turnover in the ordinary course of business) described in the “Collateral” paragraph hereof without the prior written consent of SBA.”

Insurance

Some lenders require borrowers to carry key person life insurance or other forms of insurance to protect the lender. In the case of EIDL, the SBA requires the borrower maintain hazard insurance to protect collateral: 

Within 12 months from the date of this Loan Authorization and Agreement the Borrower will provide proof of an active and in effect hazard insurance policy including fire, lightning, and extended coverage on all items used to secure this loan to at least 80% of the insurable value. Borrower will not cancel such coverage and will maintain such coverage throughout the entire term of this Loan.

Presumably this requirement won’t apply in all cases, such as smaller loans or loans where there is no physical collateral pledged. Nevertheless, it’s an important requirement that business owners should be aware of. 

Distribution of Assets

By signing the EIDL loan agreement the borrower requires the borrower to agree not to distribute assets: 

Borrower will not, without the prior written consent of SBA, make any distribution of Borrower’s assets, or give any preferential treatment, make any advance, directly or indirectly, by way of loan, gift, bonus, or otherwise, to any owner or partner or any of its employees, or to any company directly or indirectly controlling or affiliated with or controlled by Borrower, or any other company.

What If You Can’t Pay It Back?

Given the uncertainty of today’s business environment, it’s no surprise borrowers are concerned about what happens if they cannot repay their SBA EIDL loans. The EIDL loan agreement states: 

SBA’S RIGHTS IF THERE IS A DEFAULT: Without notice or demand and without giving up any of its rights, SBA may: A) Require immediate payment of all amounts owing under this Note; B) Have recourse to collect all amounts owing from any Borrower or Guarantor (if any); C) File suit and obtain judgment; D) Take possession of any Collateral; or E) Sell, lease, or otherwise dispose of, any Collateral at public or private sale, with or without advertisement.

Defaulting on a federal loan is always a serious matter as the government has additional collection powers private creditors don’t. Even if the personal guarantee protects borrowers, defaulting may prevent a borrower from qualifying for other federal loans such as federal student loans. 

Before You Sign A Loan Agreement

None of this is meant to suggest borrowers should avoid these loans at all costs. In the current lending environment where low-cost unsecured loans can be hard to get, these loans will no doubt save some businesses. But remember that the Small Business Administration (SBA) is doing what it can to protect the lender— which in this case is the U.S. government. Your job is to protect your business. And that means reviewing and understanding loan agreements before you sign so you can make an informed decision.