Bankruptcy vs. Offer in Compromise for SBA Debt

So your facing SBA debt you cant repay—maybe a defaulted EIDL loan, maybe a traditional 7(a) loan that went bad, maybe a disaster loan from years ago that’s been haunting you—and you know you need to do something because the collections are getting aggressive and your running out of options. You’ve heard about two possible solutions: filing bankruptcy to eliminate the debt, or making an Offer in Compromise to settle the debt for less than the full amount. Both sound like they could work, but you dont understand the difference between them, which one is better for your situation, what the pros and cons are, or how to choose. Your attorney mentioned one, your accountant mentioned the other, and now your stuck trying to figure out which path to take when you dont fully understand either option.

Here’s what you need to know: **Bankruptcy and Offer in Compromise are two completely different legal strategies for addressing SBA debt you cant pay, and the right choice depends on your specific financial situation, whether you have other debts besides the SBA loan, whether you want to protect assets, and whether the SBA is even willing to consider an OIC for your particular loan**. Bankruptcy is a federal court process that can eliminate your personal liability for the SBA debt (and other debts) by discharging them, and it provides immediate protection from all collection actions through the automatic stay—but it has serious credit consequences, costs attorney fees, and requires disclosure of all your finances to the court. An Offer in Compromise is a negotiated settlement where you propose to pay the SBA less than the full amount owed in exchange for them releasing you from the debt—it can be less damaging to your credit than bankruptcy, avoids court involvement, and might cost less—but there’s no guarantee the SBA will accept your offer, the SBA has become much more restrictive about OIC especially for EIDL loans, and the negotiation process can take months with no protection from collection in the meantime.

This article explains what each option actually is and how it works, when bankruptcy makes more sense than OIC, when OIC makes more sense than bankruptcy, the key differences between them (credit impact, cost, timeline, asset protection, success rate), the specific complications with EIDL loans and OIC, whether you can try OIC first and then file bankruptcy if the OIC is rejected, and how to decide which strategy is right for your situation. If your facing SBA debt you cant repay and your trying to choose between these two options, understanding the real differences is critical to making the right decision.

What Is Bankruptcy and How Does It Address SBA Debt?

Bankruptcy is a federal legal process governed by the U.S. Bankruptcy Code where an individual or business can obtain relief from debts they cannot repay. There are different types of bankruptcy, but the two most relevant for SBA debt are Chapter 7 and Chapter 13:

Chapter 7 bankruptcy (liquidation): In a Chapter 7, your non-exempt assets are turned over to a bankruptcy trustee who sells them and distributes the proceeds to your creditors. After that, most remaining debts (including SBA loans that you personally guaranteed) are discharged—legally eliminated so you no longer owe them. SBA debt is dischargeable in Chapter 7 as long as it wasnt obtained through fraud. If you have minimal assets that are protected by exemptions (like a modest amount of home equity covered by your state’s homestead exemption, a reasonable vehicle, necessary household goods, retirement accounts), you might complete a Chapter 7 without losing any property, and you’d walk away with your SBA debt eliminated. Chapter 7 is typically completed in 4-6 months and costs $1,500-$3,000 in attorney fees plus a $338 filing fee.

Chapter 13 bankruptcy (repayment plan): In a Chapter 13, you dont liquidate assets. Instead, you propose a 3-5 year repayment plan where you make monthly payments based on your disposable income, and creditors receive a portion of what there owed based on the plan. At the end of the successful plan, any remaining balances (including remaining SBA debt) are discharged. Chapter 13 lets you keep assets that would be liquidated in Chapter 7, but it requires you to make plan payments for years. It’s more expensive (attorney fees might be $3,500-$6,000) and takes longer, but it protects property you want to keep.

The key benefit of bankruptcy for SBA debt: Once you file, the automatic stay immediately stops ALL collection actions—wage garnishments stop, bank levies cant happen, lawsuits are paused, harassing phone calls must cease. And once you receive your discharge, the SBA legally cant pursue you for the debt anymore. Your personal liability is eliminated. However, if the SBA has a lien on property (like a UCC lien on business equipment or a judgment lien on your home), bankruptcy might not eliminate the lien—it eliminates your personal obligation to pay, but the lien might survive and remain attached to the property (this gets complicated and depends on circumstances, but the point is bankruptcy doesnt automatically wipe out secured claims).

What Is an Offer in Compromise and How Does It Work?

An Offer in Compromise (OIC) is a negotiated settlement where you propose to pay the SBA less than the full amount you owe in exchange for them releasing you from the debt. It’s not a court process—it’s a negotiation between you (or your attorney) and the SBA (or the lender who made the loan, if it’s a traditional 7(a) loan guaranteed by the SBA).

Here’s how the OIC process typically works for SBA-backed loans:

Step 1: Business closure and asset liquidation. The SBA generally requires that your business be closed (not just struggling—actually dissolved and no longer operating) before they’ll consider an OIC. The logic is that if the business is still operating, it might recover and be able to repay the full debt, so there’s no reason for the SBA to settle for less. You also need to have liquidated business assets and applied the proceeds to the debt—the SBA wants to see that you’ve done everything possible to repay from business resources before asking for a settlement.

Step 2: Financial disclosure. You submit comprehensive financial information showing your current income, assets, expenses, and liabilities. For OIC purposes, this includes personal financial information even if the loan was to a business entity, because the SBA wants to know your ability to pay if you personally guaranteed the loan.

Step 3: Calculation of Reasonable Collection Potential (RCP). The SBA calculates how much they could realistically collect from you over time through forced collection—wage garnishment, asset seizure, etc. This is called your Reasonable Collection Potential. Your OIC offer needs to be at least equal to your RCP for the SBA to consider it seriously. If the SBA calculates that they could collect $50,000 from you over the next few years through garnishment, offering them $20,000 to settle wont work—they’d reject it because they can collect more by pursuing forced collection.

Step 4: Offer submission. You submit a formal OIC proposal explaining why you cant pay the full amount, what your offering to pay (usually a lump sum or short-term payment plan), and why the SBA should accept it. The offer should be supported by financial documentation proving you genuinely cant pay more.

Step 5: SBA review and decision. The SBA reviews the offer and either accepts it, rejects it, or counteroffers with different terms. If accepted, you pay the settlement amount, and the SBA releases you from the remaining debt. If rejected, your back to square one with the full debt still owed and collection continuing.

The key benefit of OIC: If successful, you settle the debt for less than you owe, and its generally less damaging to your credit than bankruptcy. The key downside: Theres no guarantee the SBA will accept your offer, the process can take many months, and you have no protection from collection while the OIC is being negotiated—the SBA can still garnish your wages, offset your tax refunds, and pursue other collection actions while your offer is pending.

Key Differences Between Bankruptcy and OIC for SBA Debt

Here are the critical differences you need to understand when deciding between bankruptcy and Offer in Compromise:

Credit impact: Bankruptcy appears on your credit report for 7 years (Chapter 13) or 10 years (Chapter 7) and has a severe negative impact on your credit score—typically dropping it by 150-200+ points. Everyone sees that you filed bankruptcy, and it affects your ability to get new credit, employment in some fields, professional licenses, and more. An OIC doesnt necessarily appear on your credit report at all—the settled debt might show as “paid for less than owed” or “settled,” which is negative but not as devastating as bankruptcy. If the SBA debt wasnt reported to credit bureaus yet (which can happen if its a business-only debt and you didnt personally guarantee it), settling via OIC might have minimal credit impact compared to bankruptcy.

Cost: Bankruptcy attorney fees range from $1,500-$6,000 depending on complexity and whether its Chapter 7 or Chapter 13, plus court filing fees of $338 (Chapter 7) or $313 (Chapter 13). OIC typically doesnt have court costs (no filing fees), but if you hire an attorney to negotiate the OIC, there might be attorney fees (often less than bankruptcy fees—maybe $2,000-$4,000 depending on complexity), plus whatever settlement amount you agree to pay. So the total “cost” of OIC is attorney fees + settlement amount, while the “cost” of bankruptcy is attorney fees + filing fee + potentially losing non-exempt assets.

Timeline: Chapter 7 bankruptcy is typically completed in 4-6 months from filing to discharge. Chapter 13 takes 3-5 years (the length of the repayment plan) before discharge. OIC negotiations can take 6-18 months depending on how responsive the SBA is, whether they request additional documentation, whether there’s back-and-forth negotiation, and whether they accept, reject, or counter. There’s no set timeline for OIC—it depends on the negotiation.

Protection from collection: Bankruptcy provides immediate protection through the automatic stay—the moment you file, all collection must stop (with very limited exceptions). OIC provides NO protection during negotiation—the SBA can continue garnishing wages, offsetting refunds, and pursuing collection while your offer is under review. This is a major practical difference. If your wages are being garnished right now and you need it to stop immediately, bankruptcy accomplishes that; OIC doesnt.

Addressing multiple debts: Bankruptcy can discharge ALL your qualifying debts in one proceeding—SBA loan, credit cards, medical bills, personal loans, deficiency balances from repossessed vehicles, etc. One bankruptcy filing can wipe out everything (except non-dischargeable debts like student loans, recent taxes, domestic support). OIC only addresses the specific SBA debt your negotiating—it doesnt help with your other creditors. If you have $200,000 in SBA debt plus $50,000 in credit cards plus $30,000 in medical bills, bankruptcy eliminates all of it; OIC only eliminates the SBA debt, and you still owe the other creditors.

Success rate and certainty: If you qualify for bankruptcy (meet the means test for Chapter 7 or can afford the plan payments in Chapter 13) and you didnt commit fraud, your bankruptcy discharge is nearly certain—the vast majority of bankruptcy cases that are filed result in discharge. OIC has NO guarantee of success—the SBA accepts somewhere around 35-50% of OIC offers (estimates vary), meaning theres a real chance your offer will be rejected and you’ll have wasted months negotiating with nothing to show for it.

Business continuation: Bankruptcy typically requires closing the business (especially Chapter 7, though some businesses continue through Chapter 13 or Chapter 11). OIC also generally requires business closure—the SBA wont settle if the business is still operating because it might recover. So neither option is great if you want to keep the business running, but both typically require closure.

The EIDL Complication: OIC May Not Be Available

Here’s a critical issue that many borrowers dont realize: **The SBA has been extremely restrictive about accepting Offers in Compromise for COVID-19 EIDL loans, and there are reports that OIC is no longer available at all for EIDL debt**. While traditional SBA 7(a) loans and some other SBA disaster loans have historically been eligible for OIC, EIDL loans (especially COVID EIDL) are treated differently.

Some sources report that the SBA has stated EIDL loans do NOT qualify for the OIC process, period. Other sources report that OIC for EIDL is available but with much stricter requirements and lower acceptance rates than for traditional SBA loans. The situation is confusing and seems to vary depending on when you inquire, who you talk to at the SBA, and whether your loan has been referred to Treasury.

If your debt is an EIDL loan and your considering OIC, you need to verify with the SBA whether OIC is even an option before investing time and money in preparing an offer. If OIC isnt available for EIDL loans, then bankruptcy might be your only realistic option for eliminating the debt (other than paying it in full, which you cant do, or waiting decades for the statute of limitations to expire and hoping the government doesnt renew collection efforts).

For traditional SBA 7(a) loans, 504 loans, and pre-COVID disaster loans, OIC is generally available and has been used successfully by many borrowers. But for COVID EIDL specifically, assume OIC might not be available unless you confirm otherwise.

Can You Try OIC First, Then File Bankruptcy If It Fails?

Yes. This is actually a common strategy: Attempt to negotiate an OIC first, and if the SBA rejects your offer or counteroffers with terms you cant afford, file bankruptcy as Plan B. There’s no legal prohibition against trying OIC and then filing bankruptcy if the OIC doesnt work out.

The advantages of this approach: You avoid bankruptcy if the OIC succeeds, which means less credit damage and avoiding the bankruptcy stigma. You gain information during the OIC process about the SBA’s willingness to settle and what they think your case is worth, which can inform your decision about whether bankruptcy is necessary. And if you ultimately file bankruptcy, having attempted OIC in good faith demonstrates to the court that you tried to resolve the debt outside of bankruptcy.

The disadvantages: It takes time—you might spend 6-12 months negotiating an OIC that ultimately gets rejected, and during that time the debt is growing with interest and penalties, collection actions might continue (wage garnishment, tax refund offset), and your financial situation might deteriorate further. Also, during OIC negotiations you have to disclose detailed financial information to the SBA, and that information might later be used against you if you file bankruptcy and the SBA objects to your discharge or challenges your exemption claims (though this is relatively rare in practice).

If your considering the “OIC first, bankruptcy if it fails” strategy, work with an attorney who understands both processes. The attorney can help you determine whether your financial situation even supports a realistic OIC offer, whether the SBA is likely to accept it, and whether filing bankruptcy now might be smarter than spending months on an OIC that’s likely to be rejected. Dont waste 6 months on an OIC that has no realistic chance of success when you could file bankruptcy now and be done with the debt in 4 months.

When Does Bankruptcy Make More Sense Than OIC?

Bankruptcy is typically the better choice if:

You have multiple large debts beyond the SBA loan. If you owe $150,000 to the SBA, $40,000 in credit cards, $25,000 in medical bills, and $20,000 in other debts, bankruptcy eliminates all of it in one proceeding. OIC only addresses the SBA debt, leaving you still owing the other creditors. When you have substantial debts to multiple creditors, bankruptcy’s ability to discharge everything at once makes it more efficient.

You need immediate protection from collection. If the SBA is currently garnishing your wages and you cant afford to lose 15% of every paycheck while negotiating an OIC for 6-12 months, bankruptcy’s automatic stay provides immediate relief. The garnishment stops the day you file. With OIC, the garnishment continues during negotiations.

You have few assets to lose in Chapter 7. If you dont own a home (or have minimal equity), dont own valuable vehicles or property, dont have investment accounts, and most of what you own is protected by exemptions, Chapter 7 costs you nothing in terms of lost assets but eliminates all your debts. In that situation, the credit damage of bankruptcy might be worth it because your not giving anything up and your getting complete debt relief.

OIC isnt available for your loan. If you have EIDL debt and the SBA says OIC isnt an option for EIDL loans, bankruptcy is your only path to eliminating the debt other than paying it in full.

The SBA has already sued you and obtained a judgment. Once a judgment exists, the SBA has less incentive to settle via OIC because they already have a legally enforceable claim. Bankruptcy can still discharge the underlying debt even after a judgment exists (though judgment liens on property might survive the bankruptcy in some cases). If your already at the judgment stage, bankruptcy is often more effective than trying to negotiate an OIC.

You dont have cash for a lump-sum settlement. Most successful OIC settlements involve paying a lump sum (or short-term payment plan of a few months). If you dont have cash available to fund a settlement, OIC doesnt work. Bankruptcy doesnt require a lump-sum payment—you pay attorney fees and filing fees, but you dont pay the creditors (in Chapter 7), or you pay them through a manageable monthly plan (in Chapter 13). If your broke and have no way to fund an OIC settlement, bankruptcy is more realistic.

When Does OIC Make More Sense Than Bankruptcy?

Offer in Compromise is typically the better choice if:

The SBA debt is your only significant debt. If you owe $100,000 to the SBA but your other debts are minimal and manageable (maybe $5,000 in credit cards you can pay off), filing bankruptcy just to eliminate the SBA debt might be overkill. Negotiating an OIC to settle the SBA debt for say $30,000 avoids the bankruptcy stigma and credit damage for a debt that’s isolated to one creditor.

You want to minimize credit damage. If your credit is currently good (the SBA debt hasnt been reported yet, or you’ve been making payments and are only recently in trouble), and you want to avoid the severe credit impact of bankruptcy, a successful OIC might show on your credit as “settled for less” but wont have the same devastating impact as a bankruptcy filing. If credit preservation is a priority (maybe you need to finance a home soon, or your job requires good credit), OIC is less damaging.

You have significant non-exempt assets you’d lose in Chapter 7. If you own a home with $100,000 of equity that exceeds your state’s homestead exemption, or you have investment accounts, rental properties, or valuable vehicles that arent protected by exemptions, filing Chapter 7 would result in those assets being seized and sold. If you can negotiate an OIC for less than the value of the assets you’d lose, OIC lets you keep your property while still resolving the debt.

Your income is too high to qualify for Chapter 7. If your income exceeds your state’s median income and you fail the means test for Chapter 7, your forced into Chapter 13, which requires 3-5 years of plan payments. If a successful OIC would cost you less than 3-5 years of Chapter 13 payments, OIC might be preferable.

You have professional or employment reasons to avoid bankruptcy. Some professions (law, accounting, finance, real estate, certain licensed trades) view bankruptcy very negatively, and it can affect licensing, bonding, or employment. If bankruptcy would jeopardize your career but an OIC settlement wouldnt, thats a strong reason to pursue OIC instead.

The SBA has indicated willingness to settle. If you’ve had preliminary conversations with the SBA or the lender and they’ve indicated openness to an OIC, or if your attorney has experience successfully negotiating OIC for similar loans and believes your case is strong, it makes sense to try OIC. But if the SBA has been completely uncooperative and theres no indication they’d consider settlement, bankruptcy might be more realistic.

Talk to an SBA Debt Attorney to Choose the Right Strategy

Choosing between bankruptcy and Offer in Compromise for SBA debt is a complex decision that depends on your total debt situation, your assets, your income, whether OIC is even available for your specific loan, and whether you need immediate protection from collection. Theres no one-size-fits-all answer—the right choice is highly individual.

Our firm helps clients evaluate bankruptcy versus OIC for SBA debt. We review your complete financial picture to determine which option makes more sense for your situation. We handle bankruptcy filings (Chapter 7 and Chapter 13) when bankruptcy is the path. We negotiate Offers in Compromise with the SBA and lenders when OIC is viable and likely to succeed. We advise on the “try OIC first, bankruptcy as backup” strategy when appropriate. And we’re honest about which option has the chance of success and the overall outcome for you.

If your facing SBA debt you cant repay and your trying to decide between bankruptcy and OIC, contact us today for a free consultation. We’ll review your debts, assets, income, and the specific SBA loan to determine which strategy is most likely to work. We’ll explain the real costs, timeline, and consequences of each option. We’ll assess whether the SBA is likely to accept an OIC based on your financial situation. And we’ll develop a plan to address the debt in the most effective and least damaging way possible. The consultation is free and confidential, but it could be the difference between choosing the wrong strategy and choosing the approach that actually solves your problem.

You dont have to figure this out alone. Call us now to explore your options.