Summary
Most defaulted COVID EIDLs are dischargeable in bankruptcy. The exception is a loan obtained through fraud, which 11 U.S.C. § 523(a)(2) excepts from discharge. That exception has become materially more relevant since the SBA’s April 2026 referral of 562,000 pandemic-era loans to the Department of the Treasury and the Department of Justice. This article addresses what the government must prove, what it cannot prove merely by pointing to a default, and the procedural deadline that operates in the borrower’s favor.
What Changed in 2026
For most of the life of the COVID EIDL program, enforcement posture was restrained. The SBA extended deferments repeatedly, eventually to 30 months from the date of the note, and Treasury granted the agency an exemption from the ordinary requirement that debts delinquent for 180 days or more be referred for cross-servicing.
That exemption expired on March 31, 2026. Following its expiration, the SBA reported transferring approximately 562,000 pandemic-era loans, comprising both COVID EIDLs and Paycheck Protection Program loans, worth roughly $22 billion, to Treasury for enhanced collection. In its April 24, 2026 announcement, the agency stated that it had also transmitted the borrowers to the Department of Justice.
The scale of that referral is what makes the nondischargeability question practically important rather than academic. The SBA Office of Inspector General had previously found that, through August 2025, the agency generally had not referred delinquent COVID EIDLs to the Justice Department for potential litigation. That posture has changed.
Two clarifications are warranted, because the announcement has been read more broadly than it should be. First, the referral package was described as loans flagged for suspected fraud, which is not the same as loans on which fraud has been established. A flag is a screening output. Second, ordinary defaulted EIDLs with no fraud indicator are also moving to Treasury, so receiving a Treasury demand letter is not itself evidence that anyone has accused you of anything.
The Statutory Framework
Section 523(a)(2) excepts from discharge debt for money obtained by:
- 523(a)(2)(A), false pretenses, a false representation, or actual fraud, other than a statement respecting the debtor’s financial condition; or
- 523(a)(2)(B), use of a statement in writing that is materially false, respects the debtor’s financial condition, on which the creditor reasonably relied, and that the debtor made with intent to deceive.
For EIDL matters, subsection (B) is usually the operative provision, because the application process was documentary. Borrowers certified gross revenue, cost of goods sold, employee counts, eligibility, and intended use of proceeds, in writing, and the SBA underwrote from those figures.
The elements the government must establish under § 523(a)(2)(B) are cumulative and each one is a real hurdle:
A written statement. Present in nearly every EIDL file.
Material falsity. Not an approximation or a rounding decision. A figure materially different from reality.
Respecting financial condition. Revenue and cost figures generally satisfy this.
Reasonable reliance by the creditor. This element does meaningful work in EIDL cases. The SBA processed the program at extraordinary speed with streamlined underwriting, and borrowers can and do argue that reliance on unverified self-certifications was not reasonable where the agency chose not to verify. Courts have divided on how much accommodation to give a lender that structured its own process to forgo verification.
Intent to deceive. The government must show the borrower intended to mislead, which can be established by circumstantial evidence but cannot be inferred from the fact of nonpayment.
The standard of proof is preponderance of the evidence. Grogan v. Garner, 498 U.S. 279 (1991).
What Does Not Constitute Fraud
This distinction matters to a large number of honest borrowers who are frightened by headlines about fraud referrals.
Inability to repay is not fraud. A borrower whose projections proved wrong, whose sector never recovered, or whose business closed has not made a false representation about anything. Nondischargeability under § 523(a)(2) turns on the borrower’s state of mind and statements at the time the loan was obtained, not on how things turned out.
A good-faith estimate is not a material falsehood. Many applicants completed revenue fields without formal financial statements in front of them, working from memory or incomplete records during a period of genuine chaos. An honest error is not an intent to deceive.
Ordinary business use of proceeds is not misuse. COVID EIDL proceeds were permitted for working capital and normal operating expenses, which properly includes payroll, rent, utilities, inventory, and reasonable owner compensation consistent with pre-pandemic practice. Paying yourself a salary from working capital is not diversion.
Where genuine exposure exists, it tends to look different: revenue figures inflated by a multiple rather than a margin, employee counts for employees who did not exist, applications filed for entities that never operated, multiple applications for the same business, or proceeds moved immediately to plainly personal acquisitions unconnected to the business.
The Deadline That Protects the Borrower
The most consequential procedural point is one the government cannot afford to overlook and often does.
Section 523(a)(2) is not self-executing. Under 11 U.S.C. § 523(c)(1), a debt of the kind specified in § 523(a)(2) is discharged unless the creditor requests a determination of dischargeability. Bankruptcy Rule 4007(c) requires that the complaint be filed no later than 60 days after the first date set for the meeting of creditors under § 341(a). The deadline may be extended only on motion filed before it expires.
The practical consequence is significant. If the SBA or the Justice Department does not commence an adversary proceeding within that window, the debt is discharged even if fraud could have been proven. Given the volume of loans just referred and the resource constraints on any agency processing hundreds of thousands of accounts, the 60-day period is a real constraint on the government rather than a formality.
This cuts the other way on timing strategy. It is not a reason to file quietly and hope, because the government does receive notice of the filing and the deadline. It is a reason to understand that the exposure is bounded and defined rather than open ended.
Related Provisions Worth Noting
- 523(a)(4), fraud or defalcation in a fiduciary capacity, embezzlement, or larceny, can be pleaded alongside § 523(a)(2) in cases involving diverted proceeds.
- 523(a)(13) renders nondischargeable any debt for payment of an order of restitution issued under title 18. A borrower who has been criminally charged and ordered to pay restitution cannot discharge that restitution obligation, which is a separate and more absolute problem than a civil nondischargeability claim.
Corporate debtors in Subchapter V. For a corporate debtor obtaining a discharge under 11 U.S.C. § 1192 following a nonconsensual plan, § 1192(2) excepts debts of the kind specified in § 523(a). Whether the § 523(a) exceptions apply to corporate rather than individual Subchapter V debtors has divided the courts, with the Fourth Circuit holding in Cantwell-Cleary Co. v. Cleary Packaging, LLC, 36 F.4th 509 (4th Cir. 2022), that they do, and other courts reaching the contrary result. Counsel evaluating a corporate Subchapter V case with fraud exposure should treat the question as unsettled.
Criminal exposure is separate. Nondischargeability is a civil question. Statutes including 18 U.S.C. § 1014, which addresses false statements to influence a federal agency including the SBA, operate independently, as does the False Claims Act at 31 U.S.C. § 3729. A bankruptcy discharge does not resolve criminal liability, and nothing said in a bankruptcy case is confidential.
What Borrowers Should Do
If you have received nothing but collection notices, you are almost certainly in the ordinary default population and the dischargeability analysis is straightforward.
If you have received an Office of Inspector General inquiry, a grand jury subpoena, a civil investigative demand, or contact from an Assistant United States Attorney, stop and obtain counsel before filing anything and before responding. A bankruptcy petition is a sworn document, the schedules and statement of financial affairs are made under penalty of perjury, and the § 341 examination is testimony. Filing into an active investigation without coordinated advice is how a civil problem becomes a criminal one.
If your application contained figures you cannot support, raise it with counsel directly and early. It is a materially different conversation, but it is one with strategy available to it. It is not a conversation improved by concealment, and schedules that omit the issue are worse than schedules that disclose it.
Frequently Asked Questions
Does the SBA’s fraud flag mean I have been accused of fraud?
No. A flag is the result of a screening process. It is not a charge, a finding, or an allegation directed at you.
Can the SBA object to my discharge entirely, not just this debt?
Those are different remedies. Section 523(a)(2) excepts one debt from discharge. Section 727(a) denial of discharge is broader and requires different conduct, generally concealment of assets, false oaths in the case itself, or destruction of records.
If the DOJ sues me for the debt, does bankruptcy stop it?
Yes, the automatic stay under § 362(a) halts a pending collection action. Whether the debt is ultimately discharged is a separate question resolved through the adversary process.
How long does the government have to challenge dischargeability?
Sixty days after the first date set for the § 341(a) meeting of creditors, absent a timely motion to extend.
Is a PPP loan analyzed the same way?
The framework is the same. The certifications differ, and PPP forgiveness applications created an additional set of written representations that can be examined.
This article is general commentary on bankruptcy law and is not legal advice. It does not address criminal defense, and a borrower facing a federal investigation should consult counsel experienced in that area. Jenny R. Kasen is admitted to practice before the United States Bankruptcy Courts for the District of Delaware, the District of New Jersey, the Eastern District of Pennsylvania, and the Southern District of Florida.