More Americans than ever have been able to enjoy the freedom, and the responsibility, of being a small business owner (“SBO”). Entrepreneurship can be both an extremely rewarding and extremely risky proposition. This self-starting demographic in many cases has not only developed unique and innovative products or services, but has sought professional assistance to create the right business entity as a vehicle for their efforts and to protect and separate their personal interests from their professional ones. In many cases these intrepid individuals form limited liability companies or a closely held corporation under Subchapter S. However, the shield from liability of company debt can be compromised if certain formalities are not observed.
Moreover, because revenue streams for small businesses can be somewhat erratic, many SBOs opt for credit lines and short-term loans to bridge the income gap. However, although such loans are highly regulated in the case of a consumer loan, loans in the name of a SBO’s company are considered commercial, and are not subject to consumer protections. As such, various so-called lenders have arisen to take advantage of this niche market and in some cases, trap the unwary SBO in a loan that has wide ranging implications to the SBO if his or her company ultimately fails.
These essentially predatory lenders offer attractive options for quick and easy “signature” loans that are often handled entirely over the internet. In many cases they advertise that no personal guarantees are required. However, a close look at the fine print may show this not to be the case at all. In such cases, the SBO who signs on the dotted line may have just executed a personal guarantee that bypasses the corporate veil of limited liability, and if the SBO defaults on the loan due to financial difficulty, that SBO may find their personal finances and assets in jeopardy.
So, what should the wise SBO do?
First, make sure that you are engaging only with a reputable lender. Finance companies that previously made their money dealing in subprime mortgages and what the industry refers to as “C paper” were hit hard when the real estate bubble burst in the early 2000s. Some of them found new life in the post-Obama era by lending to small businesses at high interest rates or with hidden liabilities. Therefore, the SBO’s may be better off going to their local bank or credit union and avoiding independent finance companies altogether.
If it isn’t possible to stick to a mainstream commercial lender, make sure that you are dealing with a lender that has a good rating, or is in good standing with the Better Business Bureau, the FDIC, the Office of Thrift Supervision, and/or FINRA (if the SBO is dealing with an investment company), or state regulatory agencies for state-chartered banks or lenders.
Second, make sure that you fully review any contract and all addenda before signing anything. Although the lender may promise a quick turnaround for much-needed funds, prudence is the better part of valor. If at all possible, have your contract reviewed by an attorney skilled in matters involving the lending industry and closely-held businesses. Most importantly, if you see a “personal guaranty” as part of your signature packet, think twice before agreeing to this loan. You may be signing away your personal assets by accepting funds under such terms.
All right, thanks for the advice, but what do I do if I’ve already signed such an agreement and the lender is attempting to sue me personally?
One of the tactics used by predatory lenders is to attempt to sue the SBO in a foreign state, possibly with the belief that the SBO will not appear to defend themselves, or because the foreign state has laws that the lender views as more favorable to it. In such a case, the SBO may not have the requisite contacts with the forum state for the lender to successfully sue in that state. In order for a court in another state to have personal jurisdiction over a defendant, one of two types of circumstances must exist:
- The SBO must have either had “continuous, substantial, and systematic” contacts with that forum state. In other words, the SBO must regularly do business in that state. This is what is known as “general jurisdiction.”
- The second type of circumstance, “specific personal jurisdiction,” occurs when the transaction in question took place in the forum state. For example, in most jurisdictions, a contract is formed in the locale where it is signed. Therefore, an argument may exist that the foreign state court cannot exercise specific jurisdiction over the transaction if the contract was formed and performed elsewhere.
If the lender cannot establish one of the two types of personal jurisdiction over the SBO in the court that it chose, the SBO may be able to successfully prevent the case from moving forward in that court by making a motion to dismiss for lack of personal jurisdiction. It is important to note, however, that if the lender does not prevail in the face of a jurisdictional argument, the lender may choose to file a new lawsuit in the SBO’s home state. If that occurs, there may be other defenses available to the SBO in his or her home jurisdiction.
Unless and until the state legislatures pass laws to protect SBOs from predatory lending practices, SBOs will need to remain particularly vigilant in protecting their interests. It is far better to delay a few days in securing a loan rather than risk the personal liability the SBO organized to avoid.
If you've signed a business loan or would like an attorney to review the loan documents, please feel free to contact us.
 See, e.g., Code of Virginia, § 6.2-1816, relating to the requirements and prohibited business methods for consumer lenders pertaining to “payday” loans.
 See Daimler AG v. Bauman, 134 S. Ct. 746, 761 (2014) (“Our cases have long stated the rule that a defendant’s contacts with a forum State must be continuous, substantial, and systematic in order for the defendant to be subject to that State’s general jurisdiction.”)