Most restaurant owners who default on a loan do not plan to default. They plan to catch up next month. Then the month after that. By the time they understand what default actually triggers, the process is already underway.
Default is not a single event. It is a sequence. Understanding the sequence -- what happens, in what order, and what you can do at each stage -- is the difference between a managed outcome and a personal financial crisis.
SBA loan default: the sequence
An SBA 7(a) loan is the most common financing vehicle for independent restaurant acquisitions. When a borrower misses payments, the sequence typically unfolds as follows.
At 30 to 60 days past due, the lender contacts the borrower and may offer a forbearance or deferment. This is the best time to negotiate. The lender has not yet classified the loan as non-performing, and they have an incentive to work with a borrower who is communicating.
At 90 days past due, the lender typically classifies the loan as non-performing and refers it to their special assets or workout department. The borrower is now dealing with a different team whose job is recovery, not relationship management.
At 120 to 180 days past due, the lender may demand full repayment of the outstanding balance (acceleration) and begin the process of pursuing collateral. If the loan is secured by business assets, the lender can file a UCC lien and take possession of the collateral.
If the collateral is insufficient to cover the outstanding balance -- which is common in restaurant liquidations, where equipment sells at auction for 10 to 30 cents on the dollar -- the lender submits a claim to the SBA for the guaranteed portion of the loan. The SBA then pursues the borrower for the remaining balance under the personal guarantee.
The SBA's standard operating procedures give the agency significant authority to collect on personal guarantees, including wage garnishment, bank account levies, and tax refund offsets. The SBA has 10 years to collect from the date of default.
SBA Offer in Compromise
If you have personally guaranteed an SBA loan and the business has closed, you may be eligible for an SBA Offer in Compromise. This is a settlement process that allows the borrower to pay less than the full outstanding balance in exchange for a complete release of the personal guarantee.
The SBA evaluates Offer in Compromise applications based on the borrower's ability to pay, the value of their assets, and the cost to the government of continued collection. Borrowers who have limited assets and limited income are more likely to receive favorable settlements.
The process takes 6 to 12 months. An attorney who specializes in SBA loan workouts can significantly improve the outcome.
MCA default: the sequence
A merchant cash advance default is different from a bank loan default because MCAs are not loans -- they are purchases of future receivables. The MCA provider's remedies depend on the specific agreement, but they typically include:
Freezing or redirecting your merchant account. If the MCA provider has a UCC lien on your receivables, they can instruct your payment processor to redirect all card sales to the MCA provider until the advance is repaid. This can happen quickly and without court involvement.
Confessing judgment. Many MCA agreements include a confessed judgment clause, which allows the provider to obtain a court judgment against you without filing a lawsuit. In states where confessed judgments are enforceable -- Pennsylvania, Virginia, and others -- this can result in bank account levies and wage garnishment with minimal notice.
Collection. If the MCA provider cannot recover through the merchant account or confessed judgment, they may sell the debt to a collection agency or file a lawsuit.
The Federal Trade Commission has taken action against MCA providers that use deceptive or abusive collection practices. If you are facing aggressive MCA collection tactics, document everything and consult an attorney.
Equipment financing default
Equipment financing is secured by the equipment itself. If you default, the lender can repossess the equipment. The repossession process is typically faster than a real estate foreclosure -- the lender can often repossess within 30 to 60 days of default.
After repossession, the lender sells the equipment and applies the proceeds to the outstanding balance. If the sale proceeds are less than the balance -- which is common, since restaurant equipment sells at a significant discount at auction -- the lender can pursue you for the deficiency.
If you personally guaranteed the equipment financing, the deficiency claim is personal. If you did not, the claim is limited to the business.
What to do before you default
The most important thing you can do before you default is communicate with your lenders. Lenders who are surprised by a default have less flexibility than lenders who have been in regular communication with a borrower who is struggling.
Most lenders have workout programs for borrowers in distress. These programs may include payment deferrals, interest-only periods, loan modifications, or forbearance agreements. These options are available before default. They are much harder to access after.
If you are behind on payments and cannot catch up, the time to negotiate is now -- before the loan is classified as non-performing, before the special assets team takes over, and before the lender has spent money on collection efforts that reduce their willingness to settle.
The personal guarantee question
Every default analysis for a restaurant owner has to start with the personal guarantee. What did you guarantee? What is the outstanding balance? What are your personal assets?
The answers to those questions determine your actual exposure and your negotiating leverage. A borrower with limited personal assets has more leverage in a settlement negotiation than a borrower with significant assets, because the lender knows that aggressive collection will be expensive and uncertain.
Understanding your personal guarantee exposure is not a reason to despair. It is the information you need to negotiate from a position of knowledge rather than fear.
For a look at your debt options before you reach default, Restaurant Debt Options: What Owners Actually Have covers the full range. If you are considering bankruptcy as a way to address loan defaults, Restaurant Bankruptcy: Chapter 7 vs. Chapter 11 vs. Just Closing explains what each chapter actually does. If you want a second opinion on your specific situation, book a call with Rod.