SBA Debt Attorneys

When certain limited circumstances occur and a Borrower or Guarantor does not have the ability to make full payment, the SBA may allow a settlement for less than the full principal amount due on the federal debt. An SBA Offer in Compromise (OIC) is not possible without the cooperation of responsible Borrowers and Guarantors. One of the basic elements of an SBA OIC is that the business has ceased operations and all business assets have been liquidated. The business owner’s assistance and help in maximizing the recovery on the business assets will help to minimize the amount of deficiency balance on the loan. As in most scenarios involving debt forgiveness, there may be tax implications and small business owners should consult their tax and legal advisors before starting the SBA OIC process.

The following is a general list of categories that the SBA refers to in assessing the obligor’s ability to pay:a. Forced sale equivalent (liquidation value).(1) The basis for this value is normally the amount recoverable from the sale of the assets within a limited period of time (auction type sale). Also to be considered, is the time and expense needed for the SBA to gain control of the asset. But generally speaking, the SBA considers the following assets: Real Property (Commercial), (Residential), (Unimproved Land); Business Assets: (Machinery/Equipment), (Accounts Receivable/Inventory), (Furniture/Fixtures), (Leasehold Improvements).(2) The Claims Collection Act and the GAO standard provide that consideration be given to the time and monies involved with enforced collection to establish a discounted forced sales figure. The forced sale equivalent value needs to be adjusted for the following types of expenses: Court costs, filing fees; (a) Prior liens, taxes, assessments; (b) Costs of sale (auctioneer’s fees, advertising, lotting, and clean up costs); (c) Time of SBA employees (financial, legal, clerical, and administrative); (d) U.S. Attorney costs (professional, administrative, out of pocket); (e) Possibility of protested litigation or of bankruptcy and related expenses; (f) Time mandated by State redemption periods and the cost (depreciation, vandalism, insurance risks) that may result from such delays; (g) Care and protection expenses pending resale; (h) Extraordinary expenses of eviction, repairs to property, vandalism; (i) Costs necessary to bring property to marketable condition; (j) Transportation/travel costs; and (k) Discount reflecting the present value of future net recovery.b. Non-reachable assets and income.There may be items which are utilizable to the obligor(s) and have substantial value but are beyond the reach of the Government. The facts of the situation should enter into the Agency’s assessment of the obligor’s good faith.c. Jointly owned property.Special problems are encountered when the obligor shares ownership with another of an asset. This, by itself, is not sufficient reason to disregard the asset as having no value. The situation must be closely examined to determine (even to the extent of hiring appraisers and consultants) if the potential value of the property warrants further action.d. Individual asset valuations.Each worthwhile asset owned by the obligor needs to be assessed. Estimating the values of these assets is not an exact science but the SBA utilizes a uniformity of approach.(1) Cash.The SBA will only be concerned with cash in amounts substantially in excess of basic living expenses as determined from the SBA 770. Special accounts (IRA’s, Keoghs, trust accounts) should be valued net of early withdrawal penalties and other costs.(2) Cash surrender value (CSV) of life insurance.The SBA will determine the net amount receivable under the terms of the policy. Loans outstanding and other costs may also have to be subtracted out. The policy must often be surrendered in order to receive the CSV. The loan value should be used for analysis if surrendering the policy would leave the family with inadequate protection. This approach is to be used even if the Agency is acknowledged as assignee in the insurance company’s home office.(3) Accounts/notes receivable.The size, age, and collectibility of these assets will be examined to determine their worth. Typically they have little forced sale value. Ordinarily, the SBA will consider only large receivables with such attention.(4) Furniture, fixtures, and other personal effects.The SBA’s policy regarding this class of assets is that they are normally not worth very much. Efforts spent in other areas will yield much better results. The SBA will assign a nominal value to the contents of a modest home for compromise situations. If such assets are subject to an SBA lien, the lien may be realized for nominal value or the assets may be abandoned if no such release is possible.(5) Jewelry, paintings, antiques, and collections.When items in these categories have been assigned substantial value, the SBA will give them special attention. Outside sources may have to be utilized to determine meaningful values on these specialty items.(6) Automobiles.Automobiles generally have a ready market and various published books give a handy reference as to value. Gross compromise value “rule of thumb” is 80 percent of loan value. Of course prior encumbrances must be deducted to determine the net compromise value.(7) Securities.The SBA generally views the value of stocks and bonds in publicly traded firms as easily ascertainable and can quickly be converted to cash. Ownership interest in firms with closely held corporate stock and in unincorporated firms present much greater valuation problems. Each situation is considered using the best judgment available. If substantial potential worth is apparent, the SBA will obtain a valuation analysis by a chartered financial analyst or some other qualified person.(8) Other assets.Common carrier rights, copyrights, liquor licenses, patents, inheritances, and trusts are the types of assets that can be worthless or have substantial value. The SBA will confer with counsel regarding local laws and their effect on these assets. The establishment of values for these assets must rely on a reasonable assessment of the circumstances in each case.(9) Real estate.This is often the asset having the largest value on an SBA obligor’s or debtor’s balance sheet. For income producing or commercial properties, the SBA will use a member of a nationally recognized appraisal organization to conduct valuation analysis.(a) For the average residence, the SBA will consider some of the following acceptable alternatives:i. A “Property Report” by a recognized reporting service;ii. A written evaluation from a local realtor (with Multiple Listing Service (MLS) comparables);iii. A report from a residential appraiser used by Farmers Home Administration (FHA), Veterans Administration (VA), or other established mortgage lender; oriv. Any other local source you may have of similar reliability.(b) These reports usually furnish the market value of the property. However, this is not sufficient for SBA valuation purposes. The following must also be weighed:i. State redemption periods, homestead exemptions, and the like.These can substantially delay or negate the SBA’s ability to get the property: SBA will have to consult with counsel if there are any questions on the impact of this type of legislation. The value analysis must consider the recovery impact of local laws.ii. Policy regarding primary residence.Both the Department of Justice (DoJ) and SBA have strong positions regarding foreclosing on homes. For the SBA, a foreclosure action is generally considered as a very last resort. Concerted settlement efforts are generally first attempted, and fully documented in the loan file. Similarly, the DoJ will not, as a matter of policy, proceed with a foreclosure action if a reasonable settlement is at all possible or if the result will cause a cooperative debtor a severe hardship. This policy is consistent with the Claims Collection Act which says that a compromise settlement must be attempted before steps are taken to deprive obligors of their residences.

Most SBA loans fall under two categories: 7(a) and 504.In an SBA 7(a) transaction, a loan is secured from a private sector lender and, provided that the lender and borrower have satisfied the requirements of the SBA, if the borrower defaults on the loan, the SBA will reimburse the lender for a percentage on the loan loss (usually 75% or 85%, depending on various factors).In an SBA 504 transaction, typically, a loan is secured from a private sector lender with a first position lien covering up to 50% of the project cost, and a second loan is secured from a private sector lender with a junior lien position covering up to 40% of the project cost, and the borrower makes a contribution of equity equal to at least 10% of the project cost. After the closing of the first and second loans, and provided that the lender and borrower have complied with the requirements of the SBA, a debenture is sold to investors, the proceeds of which pays off the second loan, whereupon the second loan is assigned to a Certified Development Company (“CDC”) and then to the SBA, which provides a 100% guarantee of the debenture.The existence of the SBA’s guarantee in each of these transactions is an inducement for the lender to make a loan on terms it would otherwise not make. However, the SBA guarantee does not allow the lender to disregard standard commercial underwriting principles such as collateral and personal guarantees. The SBA guarantee does allow the lender to loan more money, extend longer terms, and approve loans to less mature businesses than it otherwise would.The SBA’s purpose under these financing programs is to help businesses gain more access to capital, thereby creating jobs and expanding the tax base. Pursuant to the Small Business Jobs Act of 2010 (“2010 Act”), the maximum SBA guarantee to the lender on a 7(a) loan was increased to $5,000,000; and on a 504 Loan, the maximum debenture amount was increased to $5,000,000.

The adequacy of an SBA OIC must begin with an evaluation of the assets of the obligor(s). The starting point is ordinarily the net present value of the forced sale value of such assets (not the loan balance). This value combined with the prognosis of the obligors’ earning power form the basis for determining the adequacy of the offer. The review must balance the right of the Government to collect the amount owed and the obligation to treat all obligors with dignity and fairness.

The new Chapter 11 Subchapter V bankruptcy has many differences from a regular Chapter 11.  For instance, some of the changes are as follows:

• Plan easier to confirm
• Only debtor can file plan
• Disclosure statement not required
• Contested plan may be confirmed over objecting impaired class
• Absolute priority rule not applicable
• No creditors committee
• No quarterly U.S. Trustee payments

These changes will result in faster and thus less expensive reorganizations for small business.