Who is Liable to Pay if You Default on a Business Loan?

Business loans can be life-saving (or business-saving in this case). As a business owner, it is not unusual to require some extra money to make ends meet. You might need the money to stock up on inventory, purchase essential business equipment, fund day-to-day business processes, etc. 

Whatever it is, it’s all in good faith, and you have every intention to pay it back on time and in full.  But things don’t always work out the way we want. Broken equipment can slow down production or kill it altogether, sales may stagnate due to competition, etc. Many unseen situations may occur that are beyond your control. You may make fatal mistakes too that may compromise your ability to repay the loan. 

One such unpredictable rough patch might become the reason you struggle to keep up with the monthly repayments. And this can easily lead to a loan default, thus putting your business in a critical situation. 

But what happens if you default on a business loan? Who is liable? Continue reading to find out what happens if a business is not able to pay back a business loan. 

What Is Default and What Qualifies as a Loan Default?

Defaulting on a loan is when a borrower is not able to pay back debt in line with the initial arrangement. It could be failing to make timely payments, missing payments or completely stopping making payments. 

If your business misses payments at a time, is late on several payments or stops paying altogether, it could be considered to be in default by the lender. 

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The number of months you will need to miss or be late before the lender can declare the loan defaulted varies from lender to lender - some lenders could count one missed payment as a default. There will be a clause on your loan agreement that specifies whether a grace period exists. 

If you meet the threshold as per the loan agreement and the lender formally declares you to be in default, the lender has the right (according to law) to take the necessary action to recover his balance on loan. 

Who Is Liable?

So what happens if you default and who is liable? The consequences of a business loan default depend on the type of loan. There are two broad possibilities.

Unsecured Loan

Typically, an unsecured loan does not require you to put up collateral. However, in most cases, the lender will require you to give a personal guarantee for the loan or put a general lien on all your business assets.

While applying for the loan, the lender will check your (or the guarantors) personal creditworthiness. If you qualify and sign a personal guarantee, you become liable for the loan balance - or at least a portion of it. 

As such, in case the business defaults on the loan, you (or anyone who signed the personal guarantee) become responsible for the remaining loan balance. As such, the lender can come after your personal assets to recoup the balance. 

Due to the high risk involved, most lenders charge a higher interest rate and might start charging late fees on the remaining balance as soon as a payment passes the due date. In addition, they can sue and obtain a court order to garnish money from the business bank accounts or even seize business and guarantors assets such as: 

• business vehicles, 
• equipment,  
• real estate owned by the business.

Secured Loan

While unsecured business loans often hang all hope on a personal guarantee, secured loans need collateral as security for the loan. Typically, the lender will request you to provide an asset that meets or exceeds the amount you intend to borrow. The asset can be equipment, real estate, vehicles, account receivables, etc. 

If your business is unable to meet the obligations of a secured loan, the lender has the right to seize the asset and liquidate it to recover the loan balance. 

Some lenders may be willing to work with you to find a solution. In fact, a lender would rather work out a payment solution with you than seize the asset because it takes time and effort to sell the asset. 

Also read: 10 Smart Reasons to Take a Business Loan

How to Avoid Defaulting on a Loan

As seen above, business loan defaulting has severe consequences on your business (and sometimes your personal assets). In addition to messing with your business credit history, defaulting on a secured business loan can be fatal to your business. 

Defaulting on a secured business loan might lead to loss of crucial business assets leading to problems with your business continuity, while unsecured loans might also affect your personal assets. 

Therefore it is important to avoid getting into the red zone. Here are some of the steps you can take to help you avoid defaulting:

• Pay when you can. If you can’t afford full installments at the end of the month, make small installments as often as you can. This will show the lender that you are making an effort, and it will be easier to negotiate a plan. 
  

• Talk to the lender. Contact the lender as soon as you realize that the business is struggling to pay the installments. If you keep an open line of communication, the lender will be happy to work a plan to help you avoid defaulting. 
  

They might defer some payments, extend the loan term or allow you to service the interest-only for a period of time until you are able to pick up the principle. 

• Seek advice from a bankruptcy lawyer. Sometimes when a business defaults on a big loan, there is a chance that bankruptcy is around the corner. It can help to check with a bankruptcy lawyer to see what options you still have on the table. 

WRAPPING UP

Defaulting on a business loan will not only hurt your business credit history, but it can even lead to business or personal bankruptcy. 

In an ideal situation, you would never default on a loan that you took to help start or grow your business. However, if it is completely unavoidable, it is important to have all the facts so you are aware of what to expect and at what stage.