Lenders, including 7(a) lenders and Certified Development Companies (“CDC”), must be proactive in recognizing when a loan should be classified in liquidation status, and understand the necessary steps in the liquidation process. Lenders who act promptly and follow the necessary steps in the liquidation process will maximize collateral recovery, limit the possibility of denial of the SBA’s guaranty purchase, and maximize reimbursement for liquidation expenses.
Preparing for Liquidation Status
Lenders are required to service and liquidate loans consistent with prudent and commercially reasonable lending standards. This includes continuously reviewing and monitoring borrower’s financial and operational conditions on an on-going basis; providing regular reporting to the SBA and to the appropriate credit reporting agency; and identifying early warning signs that a borrower is experiencing financial trouble. Early warning signs that the borrower might be experiencing financial trouble cannot be overlooked. For example, if a borrower fails to make required insurance premium payments, fails to pay taxes when due, fails to provide required financial statements, or there is an increased frequency and duration of slow payments, this should trigger the lender to investigate further. Oftentimes, lenders’ billing/accounting systems will automatically flag a loan if there is an overdue payment. However, lenders should scrutinize the financial statements that their borrowers are required to submit on a periodic basis; contact the borrower or conduct site visits to stay informed; and/or review credit reports, credit scores, and tax returns to reasonably forecast troubled loans.
If issues or concerns are uncovered, lenders should diligently address them with the borrower. Proactively addressing issues and red flags upfront with the borrower concerning their financial ability to make payments will ensure the interests of the lender and SBA are protected, and increase recoveries during potential liquidation actions.
Classifying the Loan in Liquidation Status
SBA loans must be classified in liquidation status if any of the adverse events listed below occur:
- The loan is more than 60 days past due with no prospect of a deferment or a workout;
- A third-party lender or another senior lienholder has initiated a foreclosure action against collateral securing the loan;
- A lawsuit, which will adversely affect repaying of the SBA loan, has been initiated against an obligor;
- An obligor has filed a voluntary petition in bankruptcy, or an involuntary petition in bankruptcy has been filed against an obligor;
- The borrower’s business has been shut down or abandoned and the obligors have not made other arrangements to repay the SBA loan;
- Substantial collateral has been abandoned or is in danger of disappearing, losing its value, or being stolen;
- A receiver has been appointed by a court, or some other action has been initiated to liquidate the collateral or an obligor’s assets; or
- Any other circumstances that could substantially and adversely affect repayment of the SBA loan.
See SOP 50 51 3.
If one of the adverse events listed above occurs, the next appropriate step is to accelerate the indebtedness. Once the loan is accelerated, a demand letter should be sent to all of the obligors for immediate payment of the outstanding balances, unless prohibited by law (e.g. automatic stay in bankruptcy). Next, the status of the loan must be transferred to liquidation status.
Transferring the Loan to Liquidation Status
In order to transfer an SBA loan to liquidation status, the lender must contact the appropriate SBA service center assigned to the loan. As of February 1, 2015, all 7(a) lenders are required to notify the SBA via ETran by changing the loan status to “In Liquidation.” The loan will then be transferred to the appropriate liquidation unit. SBAExpress Loans, and small loans $350,000 and under approved on or after January 1, 2014, will be liquidated by the Commercial Loan Servicing Center. All other loans will be liquidated by the National Guarantee Purchase Center.
Conducting a Site Visit
Lenders should conduct site visits frequently to stay informed about the borrower’s business operations and to facilitate prudent decision making. The SBA requires all lenders to conduct a site visit within 60 days of any uncured payment default, and within 15 days of non-payment default, such as bankruptcy filing, business shutdown, or foreclosure by a prior lienholder. Site visits should be conducted sooner if there are assets with significant value that could easily be transferred, depleted, or lost.
While conducting a site visit, lenders must prepare a detailed reporting containing an inventory of remaining assets, and an assessment of their condition and value (“Site Visit Report”). Site Visit Reports must be kept in the loan file.
Developing a Liquidation Plan
Liquidation plans are a great way of developing specific steps the lender should take to maximize recovery of collateral, and plans should be created prior to taking any material action to liquidate the SBA loan. Proposed liquidation plans must be submitted for SBA approval within 30 days of completing the site visit, along with a copy of the Site Visit Report, and demand letter. The SBA provides 7(a) lenders and CDCs with the appropriate liquidation plan format. As set out in both templates, the following factors should be discussed in the Liquidation Plan:
- Site visit findings;
- Feasibility of a Workout;
- Recoverable value of the collateral;
- Available methods of liquidation;
- Status of senior liens;
- Obligor’s repayment ability; and
- Non-SBA loans to obligor.
Obtaining SBA Approval on Liquidation Actions
The SBA will be responsible for either liquidating the loan, or overseeing the liquidation conducted by lenders. A lender is usually responsible for liquidating the loan, unless the SBA elects to take over the liquidation. See 13 C.F.R § 120.535(d). If a CDC is responsible for liquidating the loan, the loan documents must be reassigned from the SBA to the CDC.
Some liquidation actions require the SBA’s written pre-approval before the lender can take action. For a detailed list of liquidation actions that require the SBA’s pre-approval, see SBA Liquidation Actions: How to Determine Which Liquidation Actions Require SBA’s Pre-Approval for 7(a) Loans and for 504 Loans. For liquidation actions that do not require the SBA’s pre-approval, lenders must document the justifications for their decisions and retain supporting documentation in their file.
Consequences for Failure to Prudently Classify and Liquidate
It is imperative that lenders liquidate the loan in a prudent manner, in accordance with commercially reasonable standards, and comply materially with Loan Program Requirements, such as conducting required site visits. Failure to do so may result in adverse consequences.
For 7(a) lenders, the SBA may deny purchasing the guaranty. The SBA may deny liability on the guaranty when issues with lien and collateral, such as failing to properly perfect a security interest, resulted in lost avenues of recovery. The SBA may also deny liability on the guaranty for liquidation deficiencies, such as failing to conduct site visits, which result in missed recoveries.
For CDCs, if the SBA discovers fraud, negligence or misrepresentation by the CDC, the CDC must reimburse the SBA for the entire amount of the Debenture. PCLP CDCs are required by the applicable Loan Program Requirements to reimburse the SBA for 10% of any loss suffered by the SBA as a result of a default. 13 C.F.R § 120.847.
For both 7(a) lenders and CDCs, the SBA may decline to pay for all, or a portion, of legal fees and/or other costs incurred in connection with the liquidation of the loan. 13 C.F.R § 120.542.
Takeaways for Lenders
Lenders must be proactive to ensure maximum recovery in liquidation once it becomes evident that a borrower cannot repay the loan. SBA loans must be classified in liquidation status if any of the above-mentioned adverse events occur. Through early recognition of the above-mentioned factors, lenders can significantly reduce the risk of denial of a 7(a) guaranty purchase, maximize recoveries, and maximize reimbursement of liquidation expenses.
- Brandon C. Meadows, Esquire
- Melissa Murrin, JD Candidate 2021
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