SBA Loans: Offers in Compromise
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If the borrower is unable to pay the full amount owed on an SBA loan after all of the collateral has been liquidated, the borrower may submit an “offer in compromise.” An offer in comprise allows borrowers to settle their debt on the SBA loan for less than the full amount owed. SBA lenders should understand the appropriate protocols after receiving an offer in compromise from a borrower, including what an offer in compromise is, when it is appropriate, the general requirements, and the process for reviewing, approving and completing a compromise.
What is an Offer in Compromise?
An offer in compromise is an offer by the borrower to pay a portion of what is owed on the SBA loan, in exchange for the SBA to consider the debt settled or satisfied. The compromise amount must bear a reasonable relationship to the amount that could be recovered in a reasonable amount of time through enforced collection proceedings, and it must be sufficient to protect the integrity of the SBA program. Generally, the compromise amount should be more than $5,000, unless a larger amount would cause financial hardship. The compromise amount should be paid in one lump-sum payment on a specified date, usually within 60 calendar days of the approval date. Sometimes, the offer in compromise can be made in installments, if necessary, in order to maximize recovery on the loan. SOP 50 57; SOP 50 55.
All borrowers must submit their own offer in compromise to the lender or CDC. If the lender or CDC agrees with the offer, then it must send the offer to the SBA for approval. If approved by the SBA, the loan will be reclassified as “Compromise/Closed,” and the borrower will no longer be liable for any amount owed, unless the compromise was obtained through fraud, misrepresentation, or mutual mistake of fact. SOP 50 57 2; SOP 50 55.
When is an Offer in Compromise Appropriate?
An offer in compromise is appropriate when the borrower’s business has closed down and all of the collateral has been liquidated. Also, a borrower may submit an offer in compromise with a going-concern when borrower’s business is still open, but the viability of the business is at stake. However, borrowers cannot submit an offer in compromise when they are experiencing temporary cash flow problems. SOP 50 57; SOP 50 55..
What are the Requirements for an Offer in Compromise?
The general requirements for a borrower to submit an offer in compromise are as follows:
(1) The loan must be classified in liquidation status;
(2) The borrower making the offer must not be in bankruptcy, unless the bankruptcy court has permitted the compromise action;
(3) The full amount owed on the loan cannot be recovered because:
(a) The borrower is unable to pay it in a reasonable time;
(b) It cannot be collected through enforced collection proceedings within a reasonable amount of time;
(c) The cost of collection does not justify enforced collection of it;
(d) There is significant litigative risk (i.e., a real doubt concerning the ability to prevail in court because of legal issues or factual disputes);
(e) Given the borrower’s special circumstances (e.g., illness), paying it would cause financial hardship.
(4) Collection of the loan balance is not barred by a valid legal defense, such as discharge in bankruptcy or the statute of limitations;
(5) The borrower has not engaged in fraud, misrepresentation, or other financial misconduct; and
(6) The compromise amount bears a reasonable relationship to the amount that could be recovered in a reasonable amount of time through enforced collection proceedings and is sufficient to protect the integrity of the SBA loan program.
If a borrower submits an offer in compromise with a going concern, the following requirements also apply:
(1) The compromise must be necessary to avoid closure of the business;
(2) The borrower must pass the feasibility test for a successful workout set forth in Chapter 16 of the Standard Operating Procedure 50 57 or Chapter 17 of SOP 50 55;
(3) The compromise must be part of an overall debt restructuring plan that involves all of the borrower’s creditors;
(4) The specific details regarding the borrower’s secured and unsecured debt reduction arrangement with each of its creditors must be set out in a written agreement signed by all of the borrower’s creditors; and
(5) The borrower’s proposed treatment of the SBA loan must be fair and equitable in comparison to the treatment to be received by the borrower’s other creditors.
What Documentation Must the Borrower Submit?
Each borrower that submits an offer in compromise must submit the following supporting documentation:
(1) SBA Form 1150 (Offer in Compromise), or other written offer, signed under the penalties of 18 U.S.C. § 1001 for false statements, which identifies the source of the funds for the offer, and explains any special circumstances to be considered, such as illness.
(2) SBA Form 770 (Financial Statement of Debtor), or other current financial statement, signed under penalty of perjury, showing the borrower’s assets, liabilities, income, and expenses. If the borrower is a going concern, the borrower must include their last year-end financial statements. If the borrower has any affiliates, the borrower must also include a current consolidated financial statement.
(3) A complete copy of the borrower’s personal federal income tax returns for the past two years, or an explanation as to why a copy is not available, together with an executed IRS Form 4506-T (Request for Transcript of Tax Return); and
(4) For each going concern and affiliate, a complete copy of the business federal income tax returns or the past two years, or an explanation as to why a copy is not available.
Considerations When Reviewing an Offer in Compromise
Lenders and CDCs must make a good faith effort to verify the accuracy of the borrower’s financial disclosure and to evaluate the adequacy of the amount offered to settle the debt. When reviewing an offer to compromise, lenders/CDCs should:
(1) Obtain independent financial information to determine whether the financial information submitted by the borrower is complete and accurate. At a minimum, the lender must obtain a current credit report;
(2) Compare the borrower’s past financial information, current financial information, and current credit report. If there are any discrepancies, the lender must investigate them. All efforts to establish the validity of the borrower’s current financial information should be documented in the loan file;
(3) An analysis must be performed to determine the amount that could be recovered from the borrower in a reasonable amount of time through enforced collection proceedings. The lender should take the following into consideration:
(a) Recoverable value of any remaining pledged collateral that has not been liquidated;
(b) Exemptions available under state and federal law;
(c) Amount that could be recovered from the obligor’s non-exempt assets that were not pledged as collateral through enforced collection proceedings;
(d) Amount of present and potential income that could be obtained through enforced collection proceedings;
(e) Litigative risk;
(f) The necessary, reasonable, and customary administrative and litigation expenses that would be incurred through enforced collection;
(g) The time it would take to enforce collection; and
(h) The possibility that assets have been or will be concealed or fraudulently transferred.
The lender/CDC must determine whether the compromised amount is adequate, i.e. the compromise amount must bear a reasonable relationship to the amount that could be recovered in a reasonable amount of time through enforced collection. When analyzing the offer, lenders/CDCs may consider whether the borrower’s cooperation during the liquidation process increased the overall recovery on the SBA loan. If the lender/CDC determines that the offer in compromise was made in good faith, but was inadequate, the lender/CDC should make a good faith effort to arrive at an acceptable amount by submitting a counteroffer. Any unacceptable offer or counteroffer should not be forwarded to the SBA. SOP 50 57; SOP 50 55.
Obtaining SBA Approval
If the lender/CDC agrees with the borrower’s offer in compromise, the lender/CDC must submit the offer to the SBA for prior written approval before entering into a compromise agreement with the borrower. 13 C.F.R § 120.536(a)(3); SOP 50 57; SOP 50 55.. Failure to obtain the SBA’s prior written approval could result in a denial of the 7(a) guaranty.
Completing the Compromise
Once the SBA approves the offer in compromise, the lender/CDC should take the following actions:
(1) Execute a mutual release;
(2) Collect the compromised amount;
(3) Promptly apply the compromised amount to the principal loan balance;
(4) Release the appropriate loan documents after verifying that the entire compromise amount has been received; and
(5) If there is no legal remedy to collect the loan balance, such as from another borrower on the loan, submit a wrap-up report so that the remaining loan balance can be charged-off.
Conclusion
Lenders and CDCs should make a good faith effort to work with borrowers and reach an acceptable compromise amount in the event the borrower submits an appropriate offer in compromise. If you’re an SBA lender or CDC who has received an offer in compromise from a borrower, the attorneys at Jimerson Birr can help you navigate the process.
Authors:
- Brandon C. Meadows, Esquire
- Melissa Murrin, JD Candidate
Continued reading in the series:
- Which Liquidation Actions Require SBA’s Pre-Approval: Part 1 – SBA 7(a) Loan Liquidation
- Which Liquidation Actions Require SBA’s Pre-Approval: Part 2 – SBA 504 Loan Liquidation
- Classifying SBA Loans in Liquidation Status
- How SBA Lenders Ensure Expense Recovery in Loan Liquidation and Litigation
- What Responsibility and Authority do SBA Lenders Have in Servicing and Liquidating Loans?
- Loan Modification and Deferment Requirements for SBA Lenders
- SBA Loan Site Visits: How to Prepare and What to Expect
- SBA Loans: How to Maximize Recovery by Liquidating Real Property
- SBA Loans: How to Maximize Recovery by Liquidating Personal Property
- How to Maximize Recovery on a SBA Loan by Negotiating a Workout Agreement
- Assumption, Assignment and Sale of SBA Loans
- SBA Loans: Insurance Requirements and Considerations