While borrowers should repay their indebtedness in accordance with the terms and conditions of the loan, this is not always the case. Borrowers default and, as a result, lenders must liquidate and commence collection in a prompt, cost-effective, and commercially reasonable manner. However, when the defaulted loan is a Small Business Administration (“SBA”), guaranteed loan, the liquidation and collection must be consistent not only with prudent lending standards, but also in accordance with the applicable SBA Standard Operating Procedures (“SOPs”), and SBA Authorization issued at the time the loan was originated.
The SBA requires that lenders liquidate and exhaust all possible avenues of collection until a loan may be charged off and application made for payment on an SBA guaranty. However, if the liquidation and collection efforts of a lender do not comply with the applicable SOPs and SBA Authorization, and a loss results, the SBA can either deny a request for purchase of its guaranteed portion, or reduce the amount of its purchase by the amount of the loss (commonly known as a repair). Therefore, carefully adhering to the applicable SOPs during the liquidation and collection process can significantly decrease the chance of a denial or repair. Accordingly, lenders should keep these initial steps in mind when liquidating and collecting on a defaulted SBA 7(a) loan.
Know when to accelerate
When there is a default on the note for SBA 7(a) loan, a lender needs to determine whether the loan should be accelerated. Generally, a loan should be accelerated when it is clear to a prudent lender that, after a good faith effort to assist the borrower to bring the loan current, the default cannot be cured. In making this determination, lenders should rely on their own policies and procedures for similarly-sized, non-SBA guaranteed commercial loans.
Special attention should be paid to the fact that a lender’s right to accelerate amounts due under the note are different than a lender’s right to request a guaranty purchase from the SBA. Generally, a borrower must be in default on a payment for more than sixty (60) calendar days before a lender can request a guaranty repurchase. A lender may not request a guaranty repurchase based solely on a non-payment default, however this limitation does not per se preclude the lender from accelerating the note. For example, there may be instances where there is sufficient collateral to fully compensate the lender for amounts due under the note, and no purchase request will be submitted to the SBA. In these cases it may be advisable, based on the value of the collateral, the terms of the underlying documents, and the lender’s internal policies, to accelerate amounts due under the note based on a non-payment based default.
Once a loan is accelerated, it is in “liquidation” status, and the SBA will need to be notified. At this time, if the SBA guaranteed portion of the loan was sold in the secondary market, it must be repurchased.
After acceleration, a demand letter should be sent to all obligors under the loan, unless prohibited by applicable law. If the default remains uncured, lenders are responsible for conducting all steps to recover the outstanding amounts due and owing under the SBA 7(a) loan, unless and until the SBA exercises its right to take over the liquidation of the loan.
Conduct Thorough Post-Default Site Visits
Once an SBA 7(a) loan is in default, lenders should conduct a thorough inspection of the borrower’s business premise. The reason is twofold. First, it provides lenders with the opportunity to identify the status of the available collateral. An accurate assessment of the recoverable value of the collateral at an early stage of liquidation and collection is an invaluable tool that can significantly influence the recovery process, allowing the lender to quickly eliminate or solidify potential liquidation and collection options.
Second, lenders can assess whether out-of-court liquidation and collection avenues, such as workouts or repossession via self-help, are feasible. The process of resolving a defaulted SBA 7(a) loan through a workout generally avoids the liquidation of collateral by the lender. Post-default site visits may provide insight on whether an obligor can revitalize the business and possibly resolve the problems that caused the default.
A post-default site visit is mandatory unless specifically exempted. Generally, post-default site visits are required within sixty (60) calendar days of an uncured payment default. For non-payment defaults (such as bankruptcy filing, business shutdown, or foreclosure by a prior lienholder), the site visit must occur within fifteen (15) calendar days of the occurrence of the adverse event. Site visits should occur earlier if there is concern that the collateral could be removed, lost, or dissipated.
Certain loans are exempt from a post-default site visit. If the loan is unsecured, a site visit is not required. In addition, depending on the recoverable value of the collateral, a site visit may be unnecessary. If the aggregate recoverable value of the personal property collateral is less than $5,000 or the recoverable value of each parcel of real property collateral is less than $10,000, a site visit is not required.
Whether or not a loan is exempt from a post-default site visit or the site visit was conducted, all lenders must prepare a post-default Site Visit Report, explaining why the site visit was not necessary or detailing the lender’s findings from the inspection, including an inventory of the remaining collateral and an assessment of its condition and value.
Identify Competing Interests
Often, lenders will have lending relationships with borrowers, other than the SBA loan. Lenders cannot take any action in the liquidation or collection of a SBA 7(a) loan that would result in an actual or apparent conflict of interest. Any action taken by a lender must not favor recovery of the lender’s own loan over the SBA-guaranteed loan. Therefore, early in the process, it is prudent to identify any non-SBA guaranteed loans to any obligor of the defaulted SBA 7(a) loan. Proper documentation of the justification for actions taken by the lender, supporting no actual or apparent conflict of interest, will reduce the risk of a repair or denial when the lender requests a guaranty purchase from the SBA in the event of a loss.
Prepare a Liquidation Plan
Prior to initiating liquidation or collection, a Liquidation Plan should be prepared. A comprehensive liquidation plan is a great roadmap for lenders to pinpoint the specific steps it should take to maximize recovery.
Particularly, a Liquidation Plan should be prepared prior to taking any material action to liquidate an SBA loan. The Liquidation Plan should consists of, among other things, site visit findings, feasibility of workout, expected recoverable value of the collateral, available methods of liquidation, the obligor(s) ability to repay the loan, and any non-SBA loans the obligor(s) has with the lender. Unless the loan was authorized under the Certified Lender Program, a lender does not need to submit the Liquidation Plan for approval prior to implementing liquidation and collection proceedings.
Know when to submit a Litigation Plan for approval
In some cases, lenders will need to commence litigation to collect the obligations owed under the SBA loan. Prior to taking any material legal action, lenders should prepare a Litigation Plan and determine whether SBA approval is necessary. Routine litigation, such as uncontested litigation, non-adversarial matters in bankruptcy, and undisputed foreclosure actions, does not require the SBA’s prior approval, provided the estimated legal fees do not exceed $10,000.
Conversely, non-routine litigation must be approved by the SBA. Non-Routine Litigation includes:
i. All litigation where factual or legal issues are in dispute;
ii. Any litigation where legal fees are estimated to exceed $10,000;
iii. Any litigation involving a loan where a lender has an actual or potential conflict of interest with the SBA; or
iv. Any litigation where the lender has made a separate loan to the same borrower which is not a SBA 7(a).
Once legal fees exceed $10,000, all litigation is non-routine, and the Litigation Plan must be approved by the SBA. As there is a threshold dollar amount, it is vital that routine litigation legal fees are closely monitored to ensure they do not exceed $10,000.
In addition, whenever there is a material change in the litigation, including changes which may affect legal expenses, an amended Litigation Plan should be prepared and a lender must determine whether SBA approval is necessary.
Adequately Document Every Action That Does Not Require SBA Approval
The Servicing and Liquidation Matrix for SBA 7(a) loans sets forth the liquidation-related actions that lenders are allowed to take without SBA approval (with or without notice to the SBA), as well as those actions that require approval. Lenders should always document the justification for liquidation-related actions, making sure to retain supporting documentation pursuant to the applicable SBA guidelines specific to the particular action. The Servicing and Liquidation Matrix in effect at the time of the action governs whether SBA approval is required. Thus, in order to properly document the justification for taking a certain action without SBA approval, a lender should keep a copy of the Servicing and Liquidation Matrix, which it relied upon in taking such action, in the loan file.
By recognizing and implementing these careful and considered initial steps, lenders who liquidate and collect defaulted SBA 7(a) loans can significantly reduce the risk of a repair or a denial from the SBA in the event of a loss.