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Debt to a vendor could lead to
default
Dear Small Biz Adviser:
We own a small manufacturing company, an S corporation started in
1998 with a SBA loan. We were underfunded and incurred a $30,000
debt with one vendor. All other vendors are current. This one vendor
is suing for money. We have tried to obtain further financing but
have been turned down by several banking institutions. We have $40,000
equity in our house, and are rying to determine if we should borrow
on equity and pay debt or check into bankruptcy and reorganize.
Can you file bankruptcy and keep the relationships with other vendors?
How would this affect personal credit? Borrowing personally scares
me. Please help.
Tracy
Dear Tracy:
I'm going to make two assumptions:
1. That except for this debt, you're a profitable business with
solid cash flow.
2. You have thoroughly examined ways to settle the suit.
If yours is a typical subchapter S situation, personal
assets are not subject to the lawsuit. Given that same assumption,
the personal credit record is not subject to the results of the
lawsuit at hand.
However, your problem could be more complicated than
you suspect. The outcome of this matter with the vendor could rely
heavily on your Small Business Administration-backed loan. Read
the online copy of SBA
Form 148. (You'll need the free Adobe
Acrobat Reader to view it.)
It is very likely that you signed that document when
securing the SBA loan. This unconditional guarantee makes you and
any other individual signer to the loan personally liable in the
case of default. Unless you and the vendor reach an amicable resolution,
the courts could move to force immediate payment of the indebtedness.
In turn, unless you acquire the funds, the business could be in
jeopardy and, logically, the SBA loan.
This leads me to believe the vendor may be aware of
your SBA loan and the guarantee associated with it. The vendor may
recognize that a demand for total and immediate payment may force
you to default, liquidate and then pay the debt. Depending on the
amount of business and personal assets in that liquidation, the
vendor may or may not get full payment.
On the other hand, if the vendor is attempting to
leverage your SBA guarantee, it could come back at the vendor in
a negative way. SBA loan guarantees are there to make certain that
the lender gets back its money, plus liquidation costs. Any
outstanding payments to vendors come from whatever amount is left
over. The only exception to that would be any state or local jurisdictions
that override that condition. However, I would consider that very
unlikely.
Regarding the equity in your house, I am aware that
home equity lines of credit are fast becoming a more popular financing
instrument that the more traditional second lien loan process. In
deciding whether to extend a loan, and at what rate, the lender
will weigh your credit record, IRS returns of the business and amount
of equity in your house.
As for bankruptcy, it will not be a means to avoid
the liability and default liquidation process on a SBA loan. What
you need at this moment is the advice of a good, qualified lawyer
to help make the best decision for you personally and the business.
-- Posted: May 8, 2001
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