About once a week, I get a call from someone who heard about a really great strategy that is guaranteed to strip their assets of debt so they can continue to operate the business, all while getting the bank and the SBA to go away and leave them alone. While this strategy is not a new idea, the question that always comes up is: is this legal? How do lenders feel about this strategy?
Before we get into how a lender feels about an Asset Dump Buy Back, here is how it works in a nutshell:
Bob the Baker took a $500,000 loan from the Bank of Mula in order to finance the purchase of his bakery. After a few years of early mornings, late nights, and countless weekends, Bob the Baker was still in the red (i.e. NOT making money). After thinking about it long and hard, Bob the Baker decides that his business simply can’t support a $500,000 loan. He calls the bank and tells them that he will be closing his doors. In the blink of an eye, the Bank goes into liquidation mode, and immediately starts looking for a buyer of the equipment. They manage to find a buyer, which calls itself Getting A Great Deal Corp (which Bob’s friend owns), who offers $10,000 for all the business assets. While the bank is taking a bath by letting the equipment go for only $10K, they don’t really have any other alternatives, so they go ahead and sell the assets to Getting A Great Deal Corp.
Once the assets are sold, Bob the Baker submits an Offer-In-Compromise to the Bank/SBA for $20,000 (“This is all I have to offer” he tells the bank). The bank/SBA accepts the offer, thinking that litigation will get them nowhere.
After the bank/SBA are satisfied and turn their attention to other matters, Bob the Baker goes and buys the assets back from Getting A Great Deal Corp for $30,000 and VOILA! Bob the Banker has successfully traded his $500,000 loan for $50,000, AND he got to keep his business. As promised, Bob has successfully stripped his assets of debt.
Now, some points to ponder:
- In this example, the bank was unaware that they were selling the assets to a third-party who has plans to sell the equipment back to Bob the Baker. In many cases, the bank will NOT agree to such a transaction, as many banks will only sell the assets privately if the buyer is an unaffiliated third party (aka an “arms-length” transaction). It’s possible that some banks would look at this as fraud or collusion if you don’t inform them of the relationship.
- To further drive home the point above, in the SBA Offer In Compromise form, it states that one of the key elements to a workable offer is “No fraud or misrepresentation”. I’m not saying that it’s necessarily fraudulent to omit details of who the assets are being sold to, but at the same time it would not surprise me if a bank or the SBA saw it differently.
- So far, my examples have been involving private sales. In the case where it’s a public auction, anyone has a right to bid, including the business owner. To my knowledge, there is no way to prohibit an individual from attending or bidding at an auction. But again, if the bank finds out that you were re-purchasing your own equipment, that may impact whether they decide to settle or pursue you under the terms of your personal guarantee (since you are presumably going back into business, and thus might have income to repay the outstanding debt).
Overall, I subscribe to the theory that if you have to hide or omit facts, there is probably something wrong with what you are doing. Sure, it might work, and you’ll be back in business and free of debt. On the other hand, if your bank or the SBA learns the details of your plan, they could possibly accuse you of fraud. Even if you did get away with it, I feel that a Dump Buy Back falls within a very gray area in terms of ethics. If the banks and the SBA were ok with this strategy, they would simply write down loan balances (which the SBA most certainly will NOT do).
I’m sure this strategy has been performed successfully, but it’s not something I’d ever recommend to a client. I consider it my job to help business owners and not put them in harms way, and the last thing I would want to happen is for a client to go ahead and do this, only to end up with more trouble than they started with. Personal judgments and foreclosures are one thing, but when the word fraud enters the conversation, then you are potentially looking at criminal matters.
Yes, there is something to be gained from a Dump Buy Back. On the other hand, if there is the slightest chance of adverse consequence, I’d recommend just going out and buy someone else’s used equipment. That way there is no gray area from an ethical or a legal stand point.