EIDL Alert: Why You Must Read the Fine Print In Small Business Contracts

EIDL Alert: Why You Must Read the Fine Print In Small Business Contracts

EIDL Alert: Why You Must Read the Fine Print In Small Business Contracts

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. 

This article was originally written on September 16, 2020 and updated on January 11, 2021.

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ABOUT AUTHOR

Gerri Detweiler

Education Director for Nav

Gerri Detweiler is Education Director for Nav. Known as a financing and credit expert, she has been interviewed in more than 4000 news stories, and answered over 10,000 credit questions online. Her articles have been widely syndicated on sites such as MSN, Forbes, and MarketWatch. She is the author or coauthor of five books, including Finance Your Own Business: Get on the Financing Fast Track. She has testified before Congress on consumer credit legislation.

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6 responses to “EIDL Alert: Why You Must Read the Fine Print In Small Business Contracts

  1. My loan was 31000 from SBA and nothing was ever said about hazard ins until 6 months later. Also no collateral was ever listed on my application that I know of. Do I even need hazard insurance. I’m a Electrical contractor and all of my equipment consists of is my service trucks and hand tools. Thanks

    1. David – I’d recommend you talk with the SBA. They are making these loans under the guidelines for SBA EIDL loans and with the volume of loans provided there are probably some notices that went out to businesses that aren’t applicable. If you can’t get help from the SBA try your local SCORE chapter or SBDC to see if they can advise.

  2. We’ve received an email stating that “collateral ” is waived for our loan of $150k, however we’ve received another email recently asking us to provide “hazard insurance” for our collateral . We do not have collateral and it wasn’t mandatory. Should i just email the “waived collateral ” letter to SBA officer requesting the Hazard insurance? We are little confused, why would they ask for insurance for waived collateral. If we also inform that that we do not have collateral ,would that cause any issues with the loan. Thank you in advance!!

    1. The SBA is pretty overwhelmed with the huge volume of EIDL loan applications so it is entirely possible there are some confusing communications going out. I don’t speak for the SBA so please don’t take this as any kind of specific guidance for your situation.

      When it refers to waiving collateral my guess is that it means they are not requiring collateral for the loan but not that they are waiving their interest in any collateral your business does have. (Without seeing the documents though I can’t guarantee that’s what it is referring to.)

      Generally SBA loans cannot be denied solely for lack of collateral so it’s my understanding that they can’t recall the loan simply because you don’t have any collateral. It sounds to me like you will need to contact the SBA and let them know you don’t have any collateral to be insured by hazard insurance. You may have to be patient to find the right person. If you can’t make headway dealing with the SBA you may want to reach out to your local SCORE office or SBDC. You can locate them at sba.gov/tools.

      By the way, you may want to check your business credit as SBA generally places a UCC-1 filing for EIDL loans above $25,000.

      1. I received an email asking for a copy of my insurance policy. I receiver a loan for $45,000. However, I do not have equipment or real property. I provide services only. I do not have any need for a hazard policy. What should I do?

        1. Gary – I’d suggest you contact the SBA. Based on other comments it appears they are sending out these notices to borrowers, but since it doesn’t apply to your business, you’ll need to let them know that.