Can You Discharge an SBA Business Loan in Bankruptcy?

Many people take out Small Business Administration (SBA) loans to start or expand their businesses. However, if the business fails, they find themselves on the hook for their SBA loan. Luckily, by filing for bankruptcy, you can discharge (eliminate) your obligation to pay back an SBA loan. But keep in mind that if you pledged any of your assets as collateral for your loan, bankruptcy will not wipe out the lien on that property.

Read on to learn more about how you can discharge your SBA loan in bankruptcy.

What Is an SBA Loan?

The United States Small Business Administration is a federal agency that provides support to small business owners and individuals who wish to start a small business. One of the functions of the SBA is to provide loan assistance to small business owners. If you are unable to obtain a business loan through traditional lending channels, the SBA can help by guaranteeing a portion of the loan and making it easier for you to obtain the financing you need.

In most cases, you have to sign a personal guarantee to obtain an SBA loan. This means that you are personally liable for the obligation and your lender can sue you, garnish your wages, or place liens against your property if you default. However, if you can't afford to pay back your SBA loan, you may be able to eliminate your liability by filing for bankruptcy relief.

Discharging Your SBA Loan Through Bankruptcy

Starting a business is a risky venture. Many small businesses fail because of external factors such as the economy or market conditions through no fault of their owner. Because the SBA is a federal agency, many people mistakenly believe that SBA loans are not dischargeable in bankruptcy.

On the contrary, with the exception of student loans, most government loans including SBA loans can be easily discharged in bankruptcy. However, if you pledged any assets (personal or business) as collateral for your SBA loan, bankruptcy will not eliminate the lender's security interest in that property (discussed below).

Bankruptcy Does Not Eliminate Security Interests

When you file for bankruptcy, your liabilities are classified as either secured or unsecured debts. Unsecured debts include obligations such as credit card debt, medical bills, and personal loans. Secured debts include any loans where the lender has a lien on your property and can foreclose on or repossess it if you default (such as your mortgage or car loan).

In general, your bankruptcy discharge only wipes out your personal liability for your debts. It does not eliminate a lender's lien or security interest in your property. This means that if you default on a secured loan and file for bankruptcy, the lender can't sue you personally to recover its debt. But it retains the right to take back any property securing the loan through foreclosure or repossession. As a result, if you used any of your assets as collateral when you took out your SBA loan, your lender can still enforce its lien even if you file for bankruptcy relief.