Learn the important facts that every borrower and personal guarantor needs to understand if they hope to succeed with an SBA offer in compromise following an SBA loan default.
The tsunami of defaulted SBA loans is coming. For the last couple of years, it's been relatively quiet, but that's changing. Given what I'm expecting to see in the near future, I wanted to write an article that lays out what you need to know about the SBA offer in compromise (also known as an OIC) process if you hope to achieve a successful settlement and partial loan forgiveness.
Your business must be closed
To qualify for an SBA offer in compromise, the business must be closed. Several years back, a client contacted me. His business was still open, but he wanted to explore the OIC. I told him that the SBA would not be willing to consider it. He did a little research on his own and discovered that the SBA standard operating procedures (SOPs) did carve out situations where the SBA would settle with businesses that are open and operating under certain circumstances.
I explained to my client that, yes, I had seen that as well, but in practice, it was not something I've seen them do. Nonetheless, he insisted that we look at settling while the business was still open. The idea we came up with was somewhat of a purgatory situation. We were going to submit the request for loan forgiveness while the business was open, but we would commit to closing the business if and/or when the SBA approved the offer in compromise.
We submitted the OIC package and waited for a response. Not long after we submitted the offer, we got an answer back. The SBA was unwilling to consider the terms of the settlement because the business was still open. In other words, it was a nonstarter for them.
Since then, I've told this story to countless small business owners who have hoped that they could reduce their debt while remaining open. Unfortunately, in my experience, this is simply not the case, regardless of what the actual SBA SOPs state.
The business's assets must be liquidated (legally)
In most cases, liquidating the business's assets is not going to be sufficient to repay the debt in full. When people come to me and say they listed their business for sale, and they listed the price equal to the amount that they owe, I always tell them that that's not the right way to value your business. If I were a buyer, I would want to purchase a business based on what it's worth, not what the seller owes to their bank. The business's assets are usually going to sell for 15 to 20 cents on the dollar as compared to what you paid for the new, which is OK.
Selling the business assets in many cases is just a formality. If you have a service business like mine, all you really have is a desk and a computer in most situations, stuff like that is of no interest to your lender.
There's a couple of ways you can liquidate assets. You can find a buyer, you can have the bank find a buyer or the bank can put it into a general auction. No matter what you do, you must get your bank's permission before the assets are sold.
I've had situations where people sell the assets on their own and then take the money and put it toward something else like credit card debt. It can be tempting to sell the assets, but doing this will disqualify you from settling your SBA debt, and the bank won't trust you. My advice is to cooperate with the bank. If they want to sell the assets themselves, let them do it. If the bank wants you to find a buyer, post them on sites like Craigslist, or find an auctioneer who would be willing to sell them.
Home equity matters
One of the first questions I ask a potential client is, "Did you pledge your home as collateral?" Some states, like Texas, prohibit people from pledging their home as collateral.
Not all states are like this. If you pledge your home as collateral and you enough equity to cover the loan balance, you may be out of luck. If the equity in the home (after applying a discount) is sufficient to cover the loan balance, the SBA won't be interested in settling.
When we calculate how much equity is in a home, we don't take the market value minus existing loan balances. We'll take a discount off of market value since we have to assume in a foreclosure situation that a lender would account for costs such as attorney fees, realtor fees, etc.
Complete forgiveness for SBA 7(a) loans doesn't exist
If you're a borrower with an SBA 7(a) loan and you search for SBA loan forgiveness, you are not going to find anything useful. Why? Because SBA loan forgiveness has been lumped in with the Paycheck Protection Program.
Unless you have a PPP loan, you should not expect 100% forgiveness. It doesn't matter how bad your financial situation is. The SBA offer in compromise is a negotiation. You can settle for very reasonable amounts, but it won't be $0.
Be responsive to and proactive with your lender
I totally understand how stressful this situation is for you. Your business is gone due to nothing that you did wrong. A completely random pandemic ravaged our nation. Now, you're left with several hundred thousand dollars in SBA debt, and no business with which to pay it back.
The temptation is to hide, bury your head in the sand and not deal with it. However, to successfully settle your debt through the OIC program, you need to be responsive to, and proactive with, your lender.
When your banker calls you or emails, return the call or email them promptly with the information they're looking for. If you haven't heard from your lender in a few weeks and you've been waiting on them, follow up and make sure that your file didn't get lost in the cracks. I can't tell you how many people have contacted me and said, "I never heard from my bank. I thought they forgot about me. So, therefore, I did nothing. Now, I got a letter from the U.S. Treasury. What should I do?"
I tell them that, unfortunately, once it goes to the U.S. Treasury, there isn't much I can do. (More on the US Treasury below.)
Make an honest effort
I understand the temptation to fill out the paperwork as quickly as possible, send it off, close your eyes and hope for the best, but in a situation like this, you need to demonstrate that you're taking this process seriously.
If you submit an OIC that's hastily put together, your lender may assume that you're not serious about it. Sure, it will take you time to get the information they're asking for, such as your current bank balances, a summary of your personal expenses or what your regular take-home income is, but without that information, your lender and the SBA can't make an informed decision.
The OIC is based on your personal financial information. They're not using arbitrary amounts or percentages to determine whether or not you should settle. They're looking at your personal financial statement and all the other documents that go along with the OIC to make a decision.
Don't make lowball offers
The key to making a reasonable settlement offer is being realistic about your personal financial situation. Your offer needs to reflect the reality of your situation.
For sure, some of my borrowers are in very difficult circumstances and will make an offer that's consistent with that. However, I know people who, despite the fact that they can't afford to repay their SBA loan, do have resources that they can tap into. By making a realistic offer, you're signaling to the SBA lender and the SBA that you understand the parameters of their process and that you are willing to make a settlement offer that is in line with those parameters.
The 1099 is not negotiable
One of the first questions people will ask me about settlements is, "Will I get a 1099?"
In theory, the 1099 should go out if there is loan forgiveness, but I can tell you in practice that there's a lot of confusion, even among the banks. When I worked for the largest SBA lender in the country, at the end of every year, they would ask us to fill out an Excel spreadsheet. We were supposed to list what kind of 1099 they were getting and who was getting it. None of us truly understood if the 1099 was supposed to go to the borrower or the guarantor. For the most part, we sent a 1099 to the borrower, regardless of whether it was the legal entity or the personal guarantor that actually settled.
When someone takes a job, they negotiate things like salary, bonus, vacation and their title. What they can't negotiate is whether or not they get a W-2 from their employer. The IRS requires that they get a W-2, and, therefore, they do. Just like the W-2, whether or not you get a 1099 is nonnegotiable.
Lump sums are better for you (and them)
If you've ever checked out SBA Form 1150, you will see that it states that a lump sum is preferred. In a situation where you're dealing with SBA loan default, everyone involved wants to just do a deal, work out a settlement and move on.
The lender already has you as a defaulted borrower. In many cases, they're not interested in taking five more years of payments (that's the typical payment term of an OIC payment plan). The SBA is typically agreeable to monthly payments if it makes sense, but if the lender is not agreeable, there's not much you can do.
I advocate to borrowers that they should find a way to pay in a lump sum. The reason for this is that if you, for example, enter into a repayment program that is five years long, and if you miss a payment, the lender has the right to declare that settlement agreement to be null and void. They keep any payments you made up to that point, and then the entire amount of the loan could be declared due. In other words, missing a single payment, (whether it's your fault or not), could kill the settlement, and you're back to square one.
I prefer it if someone receives a lump sum from somewhere. Even if you have to make payments to that other lender, at least if you default with the other lender, you've locked in the total amount of forgiveness by paying your lump sum in a one-time payment to your lender.
The threat of bankruptcy scares no one
Pretty much every borrower I talk to mentions bankruptcy. As a former lender, the threat of bankruptcy doesn't move the needle in most cases. As a workout officer, my job was to look at what your offer is and compare it to the amount we could get (in theory, anyway) if we sue you.
When you make a settlement offer, you must make an offer that's in line with the assets and the income that you have, as opposed to expecting them to accept any offer you give because they're afraid you'll file for bankruptcy.
Doing a bankruptcy first renders you unable to settle after the fact. You'll never know what you'll be able to settle for if you do the bankruptcy first. If you attempt to settle, however, you'll know where you stand with your lender. There's nothing that says you can't start the OIC process and then file for bankruptcy if it doesn't go the way you want.
The SBA OIC process can be confusing and complicated, with lots of moving parts. The big thing about settling an SBA loan is that you have to understand the rules of the game, just like any other game in the world. If you don't understand the rules of the game, it's virtually impossible to win.