When a small business association (“SBA”) loan is converted to liquidation status, the lender must begin liquidating the collateral. If the collateral is real property, the lender must liquidate all parcels of real property that has a Recoverable Value over $10,000. If the Recoverable Value is over $10,000, the lender must decide which method of liquidation is the most appropriate to maximize the recovery. Before a lender should commence liquidation of real property collateral, it must know what is means to have a recoverable value of over $10,000, what the different liquidation methods are, and what factors should influence the decision on the most appropriate liquidation method to maximize recovery.
Is the Recoverable Value of the Property Over $10,000?
The “Recoverable Value” is “the net dollar amount that a prudent lender could reasonably expect to recover by liquidating a particular piece of collateral.” SOP 50 57. The Recoverable Value is calculated by deducting the following amounts from the amount the collateral will likely sell for, if sold quickly and with limited exposure to potential buyers:
- the balance owed on senior liens (less amounts waived or subordinated by a loan document;
- any SBA approved, necessary, reasonable and customary costs incurred that are associated with any necessary lien foreclosure action; and
- if the collateral is likely to be acquired by SBA or the lender at the foreclosure sale, the expenses associated with the care, preservation and resale of the acquired collateral.
See SOP 50 57.
If the prudent lender reasonably expects the Recoverable Value to be over $10,000, then the real property must be liquidated, unless there is a “documented compelling reason for not doing so.” SOP 50 57. If the lender commences liquidation of the real property but then realizes the Recoverable Value is less than $10,000, the lender may abandon its pursuit of recovery on the property. SOP 50 57.
There are several liquidation methods a lender must choose from before commencing liquidation of real property. In Florida, the lender can choose from the following methods:
Deed in Lieu of Foreclosure
A deed in lieu of foreclosure is an option which avoids both the time and expense of foreclosing on the real property. It involves the borrower conveying fee-simple title to the lender as a substitute for foreclosure, along with a written agreement executed by all obligors stating the amount to be applied to the balance of the SBA loan. However, lenders should only use this option if it maximizes recovery on the SBA loan. Lenders must give careful consideration on choosing this method because it may (unless otherwise negotiated in the written agreement) lose the right to collect any deficiency, and the property will remain subject to any existing liens. If a deed in lieu of foreclosure is deemed most appropriate, it is important for lenders to seek assistance from an attorney for advisement and codification of the terms of the agreement.
Florida is a judicial foreclosure state, meaning the lender must file a lawsuit in order to foreclose on real property. The lender will be required to file a verified complaint in the county where the real property is located. If the lender is successful, the court will order the property to be sold at auction, and the sale proceeds will be applied to the SBA loan. The court can also order a deficiency judgment against the debtor—that is, a money judgment—to the extent the foreclosure sale does not produce sufficient funds to pay the debt owed to lender on the SBA loan. However, foreclosures (particularly contested foreclosures) can be expensive and less efficient than other liquidation methods. Foreclosing on real property is a complex process, and this method should be pursued with the assistance of legal counsel.
A short sale is an agreement between the lender and the debtor in which the debtor sells the property for less than the amount of the total debt owed under the SBA loan. In general, a lender should not agree to a short sale if:
- The dollar amount of the sale proceeds to be received and applied against the SBA loan balance is approximately equal to or greater than the Recoverable Value of the collateral; and
- The obligor/seller will remain liable for the SBA loan balance, or approval of the short sale is part of a compromise agreement reached in accordance with Chapter 20 of the Standard Operating Procedure. SOP 50 57.
Before considering a short sale, the lender should obtain and review the following:
- real estate listing agreement;
- real estate purchase and sale agreement, short sale and all other addenda;
- current title report;
- senior lienholder, subordination, inter-creditor or other agreement with any other creditor with a lien against the property;
- transcript of account or functional equivalent for any loan secured by a senior lien;
- pre-approval letter from the buyer’s lender; and
- draft settlement statement.
See SOP 50 57.
If, after reviewing the above-mentioned documents, the lender wants to proceed with a short sale, the lender must first get permission from the SBA. The SBA has several requirements for approving a short sale, including:
- the sales price must be fair and justified by an appraisal;
- all creditors with a lien on the property must consent;
- the obligor/seller cannot receive any funds from the sale proceeds;
- the sale proceeds disbursed to senior lienholders, if any, must not include advances, default charges, or any other amount subordinated to the SBA loan by a senior lienholder, subordination, inter-creditor or other agreement;
- no sale proceeds should be disbursed to junior lienholders other than token amounts, i.e., $500 or less, if necessary, for release of lien;
- no funds credited to buyer for repairs or any other purpose;
- the obligor/seller’s closing costs should not be paid from the sale proceeds unless it is necessary under the circumstances; and
- satisfactory arrangements must have been made for payment of the SBA loan balance that will remain after receipt of the sale proceeds, unless the release is part of a compromise agreement.
See SOP 50 57.
There are many considerations to employing a short sale as an appropriate method to liquidate real property. If this method is being considered, it is important to seek assistance from an attorney.
If the obligors provide cooperation during the liquidation process and their cooperation has increased recovery efforts, allowing the obligor to conduct a voluntary sale of the property may be an appropriate option, provided the proposed transaction:
- maximizes recovery;
- the obligor has possession or control of the property;
- all other lienholders have provided their written consent to the sale;
- an appraisal has been obtained;
- the Recoverable Value of the collateral has been established;
- the sale is supervised by the lender;
- the costs of the sale are reasonable, necessary and customary;
- the lien securing the loan is only released in exchange for cash in an amount equal to or greater than the Recoverable Value of the collateral; and
- all of the net proceeds are applied to the principal balance of the SBA loan.
See SOP 50 57.
The proceeds from a voluntary sale will be applied to the balance of the SBA loan. If the obligor wants to sell the real property to another obligor, a close relative, an associate, the lender, an associate of the lender, an employee of the lender, or close relative of an employee of the lender, the lender must obtain pre-approval from the SBA. Servicing and Liquidation Actions 7(a) Lender Matrix.
How to Choose the Most Appropriate Liquidation Method
There are several methods for a lender to choose from when liquidating real property collateral. The most appropriate method depends on several, important factors, such as: whether the obligor is in active military service; the use of the property; whether there are any lienors; the amount owed on senior liens; whether the property is subject to any title encumbrance; whether the property is adequately insured; the market value of the property; and whether the property is contaminated.
A thorough investigation of all of these factors includes loan due diligence, review of the SBA loan documents, evaluation of a current title report, and ordering an appraisal, all of which are required for the lender to make a prudent decision on the most appropriate liquidation method to maximize recovery.
It is imperative that a lender consult with an attorney when determining the most appropriate method to liquidate real property. If you are an SBA lender who is considering liquidating a debtor’s real property collateral, the attorneys at Jimerson Birr can help you decide the best method of liquidating the real property and assist you in maximizing your recovery on the SBA loan in the shortest amount of time.
- Brandon C. Meadows, Esquire
- Melissa Murrin, JD Candidate
Continued reading in the series:
- Which Liquidation Actions Require SBA’s Pre-Approval: Part 1 – SBA 7(a) Loan Liquidation
- Which Liquidation Actions Require SBA’s Pre-Approval: Part 2 – SBA 504 Loan Liquidation
- Classifying SBA Loans in Liquidation Status
- How SBA Lenders Ensure Expense Recovery in Loan Liquidation and Litigation
- What Responsibility and Authority do SBA Lenders Have in Servicing and Liquidating Loans?
- Loan Modification and Deferment Requirements for SBA Lenders
- SBA Loan Site Visits: How to Prepare and What to Expect