The Small Business Administration (SBA) has been a lifeline for countless small businesses, providing vital funds through various loan programs, including the popular Paycheck Protection Program (PPP) and Economic Injury Disaster Loans (EIDL). These funds offer businesses financial support in times of economic hardship, from covering payroll and rent to addressing other essential operational expenses. Businesses can meet with SBA representatives, local experts, counselors, and business mentors at a local SBA resource center to also look at funding options.
However, with this support comes a responsibility: borrowers must use SBA loan funds strictly as intended. Misusing these funds, especially when you then file a bankruptcy, can constitute bankruptcy fraud—a severe offense with potentially devastating legal and financial consequences.
The Importance of Proper Use of SBA Loan Funds
The SBA loans intended to keep small businesses afloat during difficult times, helping businesses meet payroll obligations, pay bills, and maintain stability in their operations. For example, PPP loans were designed to primarily cover payroll expenses, with specific limitations on how much could be used for other costs, like rent and utilities. Luckily for many business owners, these PPP loans were forgiven and no repayment on those loans was required.
Similarly, EIDL loans provided broader flexibility for businesses. However, the EIDL loans came with stipulations that prohibited businesses from using EIDL funds for purposes such as expansion or certain capital expenditures.
When borrowers accept funds from the SBA, they agree to abide by the loan terms, including adhering to the proper uses outlined by the SBA. Using these funds improperly not only violates these terms but may also constitute fraud. This issue becomes even more serious if a business owner seeks bankruptcy protection which could lead to potential charges of bankruptcy fraud.
Bankruptcy Fraud: The Basics
Bankruptcy fraud is a criminal offense that involves intentionally deceiving creditors or the court to protect assets or discharge debts in a bankruptcy proceeding. Common types of bankruptcy fraud include hiding assets, falsifying documents, transferring property to others before filing, or misrepresenting financial information. The purpose of bankruptcy is to help the honest, but unfortunate debtor. In bankruptcy, the process allows individuals and businesses a fair chance to reorganize their financial obligations or liquidate assets to pay creditors. By falsifying information or failing to disclose SBA loans and how they were used, borrowers disrupt the integrity of this process, putting themselves at risk of criminal charges.
Improper SBA Fund Use in Bankruptcy: Where the Lines Cross
Using SBA loan funds improperly before or during bankruptcy can result in significant complications, especially if the business owner fails to disclose these actions. Here are a few examples where improper use of SBA funds can constitute bankruptcy fraud:
False Reporting of Fund Use: If a business owner uses SBA funds for personal expenses (e.g., buying luxury items, vacations, or home improvements) and misreports this use in bankruptcy proceedings, they may be committing fraud. Any attempt to conceal or misrepresent how funds were used can result in criminal liability. Even before that step, any misuse of SBA funds for personal use could render the debt to the SBA non-dischargeable. If the debt is non-dischargeable, you will be required to pay that loan even if you file for bankruptcy.
Transfer of SBA Funds: A borrower who transfers SBA funds to private accounts, family members, or friends and then attempting to discharge that debt in bankruptcy can face fraud charges. In this scenario, the Court will view you as having an intent to hide assets from creditors which goes against the transparent process required in bankruptcy. Moving SBA funds to non-business accounts or converting them into other assets right before a bankruptcy filing can be considered fraudulent if the intent is to conceal or misallocate these funds away from the business’s obligations.
The 4 Consequences of Bankruptcy Fraud Involving SBA Funds
Committing bankruptcy fraud is a serious offense with harsh penalties, particularly if it involves government-issued funds like SBA loans. Here are potential legal consequences:
- Criminal Penalties: Bankruptcy fraud is a federal crime. If convicted, offenders may face substantial fines of up to $250,000.00 and imprisonment for up to twenty (20) years, or both. The U.S. Courts’ website provides a video on Bankruptcy Crime. The video can be found HERE. A debtor was sentenced to more than eleven (11) years in prison for a multi-year fraud scheme which included bankruptcy fraud. The press release from the United States Attorney’s Office explaining the facts of the case can be found HERE.
- Denial of Discharge: Bankruptcy fraud can lead to the denial of a debt discharge, meaning that the debts a business owner sought to discharge or reorganize will remain. This means once the bankruptcy is completed, you will not receive a discharge and you will still owe the money to your creditors. This outcome can have severe financial consequences for you as it takes away the entire point and potential benefits of bankruptcy.
- Civil Penalties and Restitution: In addition to criminal charges, violators may be required to pay restitution or civil penalties, especially if their actions harmed creditors or misused taxpayer dollars. The SBA and Department of Justice (DOJ) may seek to recover their funds, impose civil penalties for the misuse of SBA loans, and seek attorney’s fees against you.
- Damage to Reputation and Future Borrowing Ability: A fraud conviction can damage a business owner’s personal and professional reputation, making it harder to secure loans or rebuild credit in the future. Financial institutions and lenders may hesitate to work with individuals who have been convicted of bankruptcy fraud. If you work in the type of industry that requires honesty and trust (such as a bank, or an insurance company), a fraud conviction could prevent you from gaining employment.
Preventive Measures and Legal Advice
Understanding the terms and conditions of SBA loans and the regulations governing bankruptcy is critical for small business owners. To avoid the risk of fraud, borrowers should:
Strictly Adhere to Loan Terms: Make sure that all funds are used exactly as outlined in the loan agreement. Consult with financial advisors to properly allocate loan proceeds. Speak with a bookkeeper or your tax professional to make sure you are tracing the funds correctly and accounting for where the dollars are spent. Make sure to keep receipts.
Seek Professional Guidance Before Filing for Bankruptcy: Consulting with a bankruptcy attorney and a financial advisor before filing can help avoid actions that could be interpreted as fraud. Advisors can guide borrowers in documenting fund use accurately and disclosing all necessary information in bankruptcy filings.
Maintain Comprehensive Financial Records: Keeping detailed records of all transactions and how SBA funds are used can be invaluable. Documentation not only aids in proper fund use but also serves as evidence in the event of any future inquiry or audit.
Conclusion
Improper use of SBA loan funds, especially during bankruptcy proceedings, is more than just a misstep—it is a serious offense that can lead to bankruptcy fraud charges. As tempting as it may be to leverage government funds during a time of financial difficulty, borrowers must remain diligent and transparent. Abiding by SBA loan terms and properly managing finances can prevent costly legal troubles and safeguard both personal and professional integrity. Proper use of funds not only benefits the individual business owner but also upholds the integrity of SBA programs designed to support small businesses in need.