It’s been 10 years since I starting working with SBA borrowers to navigate SBA loan default and forgiveness. At the time, I was moonlighting as a consultant by night, while working for the largest SBA lender in the USA (at the time) by day.
When I first started, I never knew (but hoped) that I’d end up working for myself, and certainly never thought that I’d have a 10 year run at it. As my clients know, running a business over a sustained period of time is a pretty tough road to hoe. There are high highs and low lows. Like many of you, I had moments when I thought “I’ve finally got this figured out!” and others when I thought perhaps the business wasn’t going to make it.
Ten years ago, I launched the business on the heels of the great recession. I honestly had no idea how good I had it. Picking up clients was like shooting fish in a barrel. There were two reasons for this:
- The recession created small business carnage unlike most of us had ever seen before, and hope to never see again. The lender I worked for had a crazy number of SBA loan defaults. There were so many, in fact, that they moved most SBA loan underwriters over to the workout group. Even with that attempt to stem the overwhelming tide, my desk overflowed with files. Before I could complete one file, there were two new ones to deal with. It was like that classic “I Love Lucy” episode where they were working on an assembly line, and the chocolates were coming faster than they could handle them. That episode was comical. Dealing with an incessant stream of SBA loan defaults was overwhelming for me, and symptomatic of a terrifying economy.
- The SBA was quite lenient when it came to approving OICs (Offer In Compromise). The first time I realized this was when I had, in the capacity of an SBA workout officer, submitted an OIC package that I thought had zero chance of being approved. When I got word back from SBA that it was approved, I was stunned. When I saw that, I knew that having insider working knowledge of the process would be a tremendous benefit to any borrower experiencing SBA default.
So the SBA was lenient in 2009. What’s it like in 2019?
I’ve seen some interesting trends since I started working as a consultant in 2009.
After about 2012, I started seeing an overall slow down in inquiries for my services. SBA defaults were down, and there were less people seeking forgiveness of their SBA loans.
I believe this was attributable to the fact that were almost 4 years removed from the “bottom” of the recession.
The other reason was that all the loans that were in default in 2008 – 2010 had finally worked their way through the system, finally landing at the US Treasury (also known as where SBA loan settlements go to die).
For those who don’t know, here’s the path that SBA loans follow once the borrower defaults:
1st Stop: Lender Services The Loan
At the time of default, the loan should still be serviced by the originating lender. The SBA generally does not service loans that they guarantee unless it’s a disaster loan. For regular 7a loans, they pay the lender who originated the loan a “servicing fee” to handle day-to-day servicing matters.
Servicing means that they handle stuff like billing and accepting payments, but it also means that they handle requests for loan modifications and loan forgiveness (i.e. they evaluate and negotiate Offers In Compromise with borrowers).
Lenders normally service SBA loans for the life of the loan. That is, unless something goes wrong along the way, such as the business closes and the guarantors don’t have the financial means to repay the debt in full.
When an SBA loan goes into arrears, the lender is required to make reasonable efforts to recover as much of the loan as possible. Reasonable efforts include working with the guarantor to submit an Offer In Compromise (if the guarantor is cooperative), but also includes taking legal action against the guarantor.
Lenders are not required to take legal action against the guarantor (I’ve heard some lenders claim this is the case, but it’s not true), but they will take legal action if it’s reasonable to think that it will result in a material recovery of cash.
If the lender feels that all avenues of collection have been exhausted, it moves along to the next stop on the train…
In what cases would it be considered “reasonable” by the SBA to take legal action against an SBA guarantor in default?
In a nutshell, if they know that the cost of recovery won’t exceed the actual recovery, legal action probably won’t make sense. In other words, if it’s going to cost $5,000 to pay an attorney to get a judgment against a guarantor who has no job and not assets, the SBA won’t require the bank to do that.
Spending money on legal action should be a business decision. If your investment in legal action would yield a positive return, the bank does it. Otherwise, they probably won’t pursue it.
I will note that I’ve seen some lenders sue people regardless of their finances, which has always made me scratch my head. My best guess is that since the SBA does reimburse lenders for legal expenses, some lenders choose to sue even if it’s unlikely to result in a recovery, but argue that it’s necessary and get reimbursed by the SBA.
On the flip side, if it’s clear that suing you will yield a sizable recovery, the lender will spend the cash to do it, and the SBA expects that to happen. It’s not free money, folks!
Anyway, back to the original question. When does it typically make sense for lenders to take legal action against a borrower who had defaulted on their SBA loan obligation?
Real Estate With Equity
The first example that comes to mind is real estate that contains substantial equity. Let’s say you pledged your home as collateral for your SBA loan. It’s worth $300,000, and has no mortgages other than the SBA lien. That would mean that, on paper, there’s $300,000 in equity in the home.
Side Bar: While the equity amounts to $300,000, most lenders will use “collateral value” as opposed to simply taking the market value minus the mortgage balance to determine equity. This is accomplished by taking the “liquidation value” of the property minus any senior mortgage balances.
“Liquidation value” takes into account the costs of foreclosure, including attorney fees, paying a realtor to sell the property, and even something called “foreclosure stigma”, which basically means people will make lower bids on a foreclosure than they would in a typical sale situation.
When calculating collateral value, most lenders will take a 10-20% discount off the market value to account for the costs of foreclosure noted above. So if the home is worth $300,000, the liquidation value will be in the range of $240,000 to $270,000.
I’d also note that when it comes to the primary residence of a guarantor, the SBA does encourage lenders to avoid foreclosure if possible. They don’t want lenders to kick people out of their homes unless there are no other options. With that said, it’s not as much a rule, as a stated position. I’ve seen banks be pretty aggressive out of the gate, so it’s not a foregone conclusion that your lender will work with you to avoid foreclosure.
With all the above said, if there is significant equity in your home, and it’s pledged as collateral, that’s a situation when a lender may opt for legal action.
Liquid assets are the low hanging fruit. So when I say liquid assets, I’m talking about checking accounts, saving accounts, obviously physical cash, investment accounts, brokerage accounts, anything that can be easily sold within a couple of days or weeks and converted to cash. The SBA really likes those because it’s not something you can argue about that you can’t sell it (like a house). It’s completely liquid. All you have to do is write them a check, hand it over and they’ve got their money. So liquid assets is definitely the first type of collateral that they look for.
If you’re earning a good salary, in most States, a lender is allowed to garnish wages. In some places it’s 25%, other places that’s less. I know for sure in places like Texas, wage garnishment isn’t allowed, but in the vast majority of States, if a lender has a judgment against you, they can garnish your wages and given that wage garnishment can basically go on indefinitely, they look at that as a really good way to recover money, and they do feel like that’s worth pursuing.
If you make $100,000 a year and your state allows even a 10% garnishment of your gross wages, that’s $10,000 a year. That’s about a thousand dollars a month. And that’s something they can continue to do month after month as long as you’re employed at that job. So that is something that a lender would look at and they would say, “you know what, it’s worth getting a judgment.”
Other Real Estate
The third situation where it would be worth it for them to consider legal action would be if you own other real estate that has equity in it. So let’s say you have a rental home, and you have some equity in it, and you have a renter in it. So they can look at that and say, “you don’t need to live in that house. You could sell it.”
And so the more equity that it is, the more likely they are to think about getting a judgment against you and really applying the pressure, whether or not they can actually foreclose on your rental property. It does vary by state. In some places they can get what’s called a “judgment lien”. So if they get a judgment against you, they can put a lien against your assets, including real estate. I’m not sure (because I’m not an attorney) if they can foreclose on it, but nonetheless, a judgment lien would mean that you couldn’t refinance or sell the property without first satisfying that judgment lien. So it’s something that lenders do look at.
And if you’ve got, and I’ve seen this, a rental property that’s unencumbered and fully paid for, it’s worth $400,000. That’s something they’re going to look at and say, “we think we can put some pressure on this person”. And so for that reason, they might pursue legal action.
When does it make sense for the SBA lender NOT to take legal action against a borrower in default?
If somebody has been working in the business as a full time employee and that business now closed, they’re unemployed so they don’t have any income.
I’ve had clients who have no income. They’ve got tons of bills to pay. They’re barely scraping by, or they’re not paying any of their bills. In that case, the lender would look at it and say, “you know what? For an unemployed person who can’t even pay their bills right now, by the time we get to judgment, they’re not gonna have anything left.”
No Liquid Assets or Real Estate
If you have liquid assets, it’s a reason to go after you. If you have none, it’s not worth it for them to pay an attorney several thousand dollars to pursue somebody who’s got, $1,000 in the bank account. It’s not worth it.
They’re not going to get a return on their investment. And like I said earlier, this whole thing really is, a business decision. If you can invest certain amount of money in your attorney, and get that back and then some that it’s worth considering.
Same deal for real estate. If you don’t own any real estate or you have no equity in your real estate, it doesn’t make sense for them to foreclose on a piece of property where they’re not going to reap any benefit.
If you have a home that’s worth $250,000 and you owe $300,00 on it, there’s no way that a junior lender like the SBA would be able to get any money out of it. Because the way a foreclosure would work would be they would actually have to pay off your first mortgage of $300,000, but then ultimately they could only sell it for $250,000. So it would be a loss for them. So they wouldn’t do it. So if you have no equity, it’s, that’s another reason why they wouldn’t pursue legal action.
If you are nearing retirement or well into your retirement, that is something they consider. The fact that you are, let’s say you’re 75 years old, clearly means that your best earning years are behind you. You’re not gonna make substantially more money in the next five or 10 years and chances are you’re going to stop working, and you’re going to be living on social security.
And so from that aspect, there’s really not an expectation that you’re going to be able to accumulate any assets or are you going to be able to increase your earning capacity going forward. Somebody who’s in their seventies or eighties or even sixties, the SBA may look at that and say it’s not worth pursuing.
The general health of the obligor is a question that the SBA does ask the lenders about. I would say there’s probably one main reason and then one peripheral reason for this question. The main reason is your health will impact your earning potential. And so if you are unable to work, then you will likely not be able to earn money. And if you’re not earning money, you can’t accumulate assets, they’ll have nothing to garnish. So if you have health problems, then that is a reason that the lender may not go after you.
The peripheral reason is I can tell you that as a former lender, if somebody legitimately had some health issues, I really just felt bad about it from a humanity standpoint. And so if it was a borderline case anyway, it was not my goal to make anyone’s life miserable, and add additional stress that could further harm their health.
These would be borderline cases, not cases where clearly they’ve got the assets and I’m just going to let them go cause they have a cold, it’s gotta be something rather severe and it’s gotta make sense for the situation.
Ok, so now we’ve covered why a lender may or may not take legal action following a default.
How To Avoid Litigation Starting In the First Place: Cooperate and Submit An OIC
And with that let’s talk about what I’m seeing in 2019 that is different than 10 years ago.
And just as a side note here, I believe that the SBA is starting to look at things a little more stringently for possibly two reasons. This is just my theory. I don’t have any confirmation on this one.
The economy’s better now than it was in 2009. Things were so bad in 2009, I think the SBA was very concerned about businesses going under, and people losing everything and really getting a bad rap for nailing people to the wall when they were at their most vulnerable.
And so what they were doing was they were doing settlements for what were very reasonable sums. And in some cases they were probably giving away the store when they didn’t have to. But I think because they were in the midst of a big panic, economically speaking, that they were trying to get through as many settlements as they could and that meant quick decisions. And that meant sometimes they were letting them slip through. That’s the first thing.
The other reason I believe may explain the SBA’s change in attitude may be because the head of the SBA changed. Linda McMahon was previously head.
She’s gone now and there’s someone new in place, and it’s possible that it’s just a top down effect that a new management team came in, reviewed what was going on and decided that the way the OIC program was being operated was too lenient, that they were going too easy on borrowers, and that they really needed to tighten up their standards for settlement.
And so those are my two theories, but let’s talk about specifics about things that I’ve seen that are different now than they were in 2009.
Your income does matter. There was a long period of time where as long as we could show them that you didn’t have enough household income to make an extra payment above and beyond your personal expenses, they weren’t so focused on the wage garnishment aspect of enforced collection.
How times have changed.
I’ve had several offers turned down recently that cited the earnings of the individual borrower, and the SBA stated that they felt that they could recover more if it was referred to treasury for further collection. And to me what that meant is they can garnish wages.
So no longer is it just enough to say “Hey, I can’t afford a payment.”
They’re really looking to see if wage garnishment is a better alternative in the long term than just taking a smaller lump sum today.
Expenses Scrutinized More
The next thing which is kind of related to the wage discussion is that expenses are being scrutinized more than they have been. Like I said earlier, if you could previously just prove to them that you couldn’t pay anything more than your regular expenses, they were fine with that. But today there really can’t be any extra meat on that bone, and you really have to show them that things are tough.
Things that are discretionary don’t count. You need to show that you can’t pay your basic expenses to live. So things like saying, “Oh my kids have to play sports and activities and that costs me $1,000 a month”, or “I have a boat payment”. Or it the SBA looks your bank statement and you go out to eat five nights a week, I believe that the SBA is looking at and saying, “you know, this doesn’t strike me as somebody who is experiencing financial hardship because of the way they spend”. And I’ll get to that specific point in a few minutes here.
Retirement Accounts Are Considered More
They’re looking at retirement accounts for the first time this year, I actually had the SBA reference retirement accounts that are completely shielded from creditors, but they pointed to them as a reason for a decline. And I’ve never had the SBA do that before.
And again, just to be clear, 401ks and IRAs, those are protected from creditors. So even if they got the judgment, they couldn’t go after them. But I think with the SBA is more trending towards is that a financial hardship needs to be demonstrated.
And that means if I’ve got $1 million in my retirement account, even though they can’t get it, the SBA is not going to be satisfied with the explanation of, “well, it shielded from credit. So I’m not going to give it to you.”
They’re looking at it as if you want to settle with them, you’ll need to dip into those accounts. Even if they know we can’t get it, they’re not going to consider this a financial hardship, and will decline the OIC.
And I actually had a client in that situation. Him and his wife are both near retirement age. They’ve got some money saved. It’s a modest amount for retirement, but it was enough to pay off the loan. And the SBA declined them. They said they were not willing to settle at all with them, which was surprising and a departure from prior decisions that I’d seen.
Element #1 Doesn’t Seem To Matter As Much
Element number one of SBA Form 770 doesn’t seem to matter as much as it used to. It says that an offer in compromise should bear reasonable relationship to the amount recoverable through enforce collection. And what that means is they’re supposed to be comparing what they can get if they sue you to what they can get, and compare that amount to the offer that’s on the table.
And so I for years have argued, particularly with the retirement account thing, that they, if they sued you, that stuff would not be possible for them to get.
Today, in 2019, it doesn’t seem that that’s a as primary a focus for them, as much as the idea of financial hardship it. So like I said earlier, financial hardship and showing that just overall that you are having a tough time and they’ll look at your credit and say, “Hey, you’re paying other creditors. So that’s an indication that you’re not having a tough time.”
So they’re really more focused on looking for financial hardship and they’re looking for different markers. If you’re paying your other bills, if you have savings, what your income looks like, stuff like that. And less on the comparison of what they can get if they sue you.
So those are the things that I’m seeing in 2019 and I’m sure we’ll see going forward in 2020, and beyond. Since I’ve covered what’s different, if this is your first time reading my site, let’s go over what’s the same about the SBA default process as it was 10 years ago.
What’s The Same (But Worth Knowing)
Business Needs To Close
I do get people who call me and say, “Hey, I would like to keep my business open. How do we go about writing down the debt while I continue to my business?”
The answer is it’s generally not possible. I’ve had the SBA tell me that you’d have to treat it like a bankruptcy, which would mean every creditor would take a similar haircut. And over the last 10 years, I’ve never seen it. So as a general rule of thumb in case unless it’s something completely wacky, the SBA is going to require you to close and they’re not even going to be willing to discuss a settlement until it’s confirmed the businesses closed and the assets have been sold.
One caveat to that is the business can be sold as a whole, as a going concern as well. Um, or a liquidation of the assets either are is fine.
The Guarantee Is For The Lender ONLY
The guarantee is for the lender only. That means that if you have a 75% guarantee and you owe $100,000, your lender will likely be reimbursed for 75% of whatever the outstanding balance of the loan is at the time of default. What it doesn’t mean is that you will have 75% of the loan balance forgiven. You have to think about it in terms of the bank is getting their money back as no bearing on you personally.
And so people come to me all the time and say, “Okay, well if the bank’s going to get their 75% back, I’ll just pay them the difference and then I’m good. Right?
The answer is no. That’s wrong. Because once the bank gets reimbursed, all that really happens is 75 cents out of every dollar that they collect has to go back to the SBA. That’s the only difference. You still owe 100% of the debt regardless if the guarantee is paid to the lender or not.
You Can’t Use Business Assets To Fund Your Settlement
So if you have a business and you’re going to shut it down and say, “Oh great, I have $20,000 sitting in my bank account, I’ll use that to settle.”
Just know that that is not something that the SBA and the lender will typically go for. Why? Well, it’s pretty simple. The SBA has a lien on all of your business assets and that includes a cash in the bank. So if in your business bank account you have cash, it’ll be expected that that just goes to loan balance to pay it down prior to any offering compromise.
So just to be clear, business assets can’t be used to find your settlement. Any settlement of your personal guarantee will need to come from personal assets. That means personal savings, that means borrowing against your personal residence. That means borrowing personally from other avenues like credit cards or home equity loans or friends or family or something like that. It can’t be any way associated with the business assets.
You Will Be Blacklisted
If you settle, you will be placed on the uh, the CAIVRS list. And this is a government list which basically blacklists you from many government subsidizes programs. So FHA loans, certain types of student loans. And of course SBA loans.
Now keep in mind the act of settling is not what puts you on this black list. It’s the act of defaulting. I like to clarify with people cause they’ll often say, “well, if I settle a will I be able to get another SBA loan?”
The answer is no.
If they lose money on you, you will not get another SBA loan, but it’s not the settlement that causes that. It’s the fact that you defaulted.
Bankruptcy Won’t Release A Lien On Your Home
This was true 10 years ago. This is true today. If you’ve specifically pledged your home as collateral for this SBA loan filing for personal bankruptcy will not release the lien on your home.
If the home has equity in it, in order to get that lien released after your bankruptcy is discharged, then you would need to go back to the lender and do a separate negotiation directly with them. If they’re a preferred lender, then they won’t need to involve the SBA because they have the authority to make that decision themselves
I often tell borrowers when they’re considering whether or not to file for bankruptcy. One thing to consider here is that they should look at how much equity is in the house, and if most of the value of a potential settlement offer would be equity in a house, I encourage them to consider an offer and compromise.
Since the cost of the lien release probably isn’t going to be that much greater than an a cost of an overall offering compromise, which potentially includes the release of your personal guarantee without having a bankruptcy on your personal credit .
Be cooperative sounds like such a simple, stupid thing, but I’m telling you as a former workout officer, people who are nice to me, who are cooperative, who are responsive, they got the benefit of the doubt.
Now for sure, it didn’t turn a no into a yes, but there were certainly people who were borderline who were just nasty to me and it just made it that much easier to say no. I’m not saying I was doing it to be spiteful, but when somebody treats you badly, you’re just not inclined to want to help them.
And so if there’s a reason to say no, then you say no. But on the flip side of that, if somebody is responsive, they’re polite, they’re courteous, they send me the information I need to do my job, then if I’m borderline, yeah I might consider a offering approving something that I might otherwise say “no” to.
You Can’t Settle For $0
And then the last thing that hasn’t changed since the very beginning is you can’t settle for $0. And this is always been the case because the SBA is not interested in letting people go for nothing.
A negotiation means you give them something, they give you something. And if you can’t come up with any money in all, unfortunately I can’t help you.
I get phone calls from people all the time who say, “look, I put all my money into this business. I have nothing left. Can you help me?”
The answer, unfortunately at that point is no, I can only help people who have something that they can offer. And the absolute minimum that the SBA will take is $5,000 but as I covered earlier, the SBA has gotten much tougher lately, so that likely does isn’t going to cut it as well.
The SBA really wants you to show them that you’ve gone above and beyond to borrow money and make good on this debt as best you can. And then at that point, they’ll make a business decision if they think that they can get more from you some how, some way down the road, they will send you to treasury, which is the worst possible place to go.
So that’s it. That’s a summary of what I’ve seen, change over the last 10 years. What I’m seeing happening in 2019 and what I expect to see in 2020 and beyond. Thanks for reading!