The pandemic has drastically changed our world in less than a year—including markets and the economy. Across all walks of business, previously thriving areas dried up almost overnight, forcing many smart and successful businesses to close.

Although Congress approved federally-funded loans for small businesses known as the Payment Protection Program (PPP), in many cases, those loans haven’t been enough.

As we near the one-year mark since the pandemic hit, small businesses across the country are finding that they need to declare bankruptcy—even after receiving a PPP loan. In fact, many businesses already have.

So, what happens if you file for bankruptcy after receiving a PPP loan?

The Difference Between Defaulting and Bankruptcy

If a borrower defaults on a loan, it means they don’t pay it back—and legal proceedings can ensue. For PPP loans—and the very similar Economic Injury Disaster Loans (EIDL) granted in response to the pandemic—collateral wasn’t required for loans up to $25,000. 

If there’s no collateral, then the lender can’t seize personal or business assets. However, the creditor can report defaulted loans to credit score companies, which means that future loans could be harder to get or only available at higher interest rates.

And because the lender for PPP and EIDL loans is the federal government, in this case the lender can seize federal assets like tax refunds.

But bankruptcy isn’t the same as defaulting on loans. 

Bankruptcy Is a Legal Process

The federal government and lenders view bankruptcy differently from defaulting on loans because it’s a legal process that provides the business with a level of protection from lenders.

In general, PPP and EIDL loans can be discharged—meaning the debt is canceled—if the business follows the proper legal process in filing for bankruptcy. 

But Complications Can Arise from PPP Applications

The one sticking point in PPP debt getting discharged comes from the loan application process. 

Because of the rush to get the PPP loans up and running, the hurriedly-written guidelines from the Treasury Department and Small Business Administration (SBA) created confusion for banks that fielded and reviewed applications.

While it was ultimately up to individual business owners to complete the applications correctly, the tumult and lack of consistency made the process rockier than ideal. And some banks may not have noticed issues at the time of application.

We are currently seeing national legal speculation around what happens if a business declares bankruptcy—which in an average situation would trigger a discharge of PPP loans—but then an error by the business is discovered in the PPP application process.

This situation has yet to play out in court, so we don’t currently have a legal precedent to look to. Whether the business would ultimately be on the hook for the loans in this scenario hasn’t yet been determined.

For businesses that received an EIDL loan, the application process went through the SBA. It doesn’t mean that the business couldn’t have made an error that was overlooked, but it does mean that the situation is less likely—because it was a more uniform and pre-existing process.

Bankruptcy Can Be a Smart Business Decision

In any article about bankruptcy, it’s worth mentioning that one hurdle small business owners face in filing is internalized stigma. So let’s just say it loud and clear—bankruptcy isn’t a sign of failure. 

Many entrepreneurs who declare bankruptcy go on to start other successful businesses. So understand that while filing for bankruptcy will likely be an emotional process, it can also be an intelligent business strategy.

Regardless of which kind of loan you received, if you have questions about filing for bankruptcy, contact us. Our experienced attorneys can guide you through the process.