How to Maximize Recovery on a SBA Loan by Negotiating a Workout Agreement
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In the event a borrower is seriously delinquent on making payments under a SBA loan, or the SBA loan is classified in liquidation status, lenders and CDCs must develop a prudent and commercially reasonable strategy to maximize their recovery on the loan. Before liquidating any collateral or incurring costs of litigation, Lenders and CDCs should make a good faith effort to first negotiate a “workout agreement” with the borrower. In doing so, Lenders must be aware of what a workout agreement is, what information should be considered before negotiating a workout agreement with the borrower, how to determine whether a borrower is a good candidate for a workout agreement, what are common workout options, what should be included in a workout agreement, and how to make the workout agreement legally binding.
What is a Workout Agreement?
A workout agreement is an agreement between the borrower and lender/CDC to resolve problems and issues arising from the borrower’s delinquent obligation to the lender/CDC. Essentially, a workout agreement restructures the material terms and conditions of the SBA loan in order to: avoid actions such as foreclosure or bankruptcy; allows the borrower to cure the default and improve their ability to repay the loan; and enables the lender or CDC to maximize their recovery on the loan. SOP 50 57; SOP 50 55.
What Information Should be Considered Before Negotiating a Workout Agreement?
In order to negotiate a SBA workout agreement with a borrower, the borrower must be cooperative and provide current financial information. The borrower’s current financial information allows the lender or CDC to make prudent lending decisions regarding the feasibility and structure of the workout agreement. The borrower must provide the following financial information:
(1) SBA Form 770 (Financial Statement of Debtor), or a financial statement signed under penalty of perjury, which includes the borrower’s assets, liabilities, income and expenses; the borrower’s last year-end financial statements; and if the borrower has any affiliates, a current consolidated financial statement;
(2) a complete copy of the borrower and each affiliate’s business federal income tax returns from the past two years, or a written explanation as to why a copy is not available; and
(3) a complete copy of the borrower’s personal federal income tax returns from the past two years, or a written explanation as to why a copy is not available.
See SOP 50 57 2; SOP 50 55.
How to Determine if the Borrower is a Good Candidate for a Workout Agreement
Once the lender or CDC receives all of the required financial information, they must review the current financial information, review the information provided in the loan documents, and conduct a site visit. Lenders and CDCs must ascertain whether a workout agreement is feasible by considering whether the borrower is: (1) competent, i.e., has the required skills to operate the business successfully; (2) cooperative, i.e., willing to take all necessary action to address the issues and problems that caused the default; (3) acting in good faith; and (4) financially and operationally viable. SOP 50 57 2; SOP 50 55.
If a workout agreement is feasible, lenders/CDCs must begin negotiations with the borrower immediately. If the parties are unable to reach an agreement within a reasonable time (e.g., 60 calendar days), the lender/CDC must move forward with liquidating the collateral. SOP 50 57 2; SOP 50 55. If liquidating the collateral is necessary, the following articles can help guide lenders and CDCs through the process: SBA Loans: How to Maximize Recovery by Liquidating Real Property and SBA Loans: How to Maximize Recovery by Liquidating Personal Property.
What are Common Workout Options?
During workout agreement negotiations, there are many workout options that the lender/CDC and borrower can consider. The most common workout options include, for example:
- Forbearance of collection activities in order to provide the borrower with an opportunity to improve its cash flow and avoid foreclosure;
- If the note was accelerated, the maturity date may be reinstated;
- Payments of principal, interest, or both, may be deferred for a stated period of time to enable the borrower to overcome a temporary cash flow problem;
- The repayment terms of the note may be modified (e.g., the interest rate may be lowered or the maturity date may be extended);
- Another person may assume the loan;
- The priority position of a lien securing the loan may be subordinated to a short-term working capital loan;
- A loan secured by a senior lien on the collateral securing the SBA loan may be kept current, purchased, or paid off; or
- The borrower may be allowed to voluntarily sell all or part of the collateral, provided that the sale is closely monitored to ensure that it is commercially reasonable and that all of the net proceeds are applied to the principal balance of the SBA loan or used to facilitate the workout plan.
See SOP 50 57 2; SOP 50 55.
What Should be Included in a Workout Agreement?
If the lender/CDC and borrower are able to reach a workout agreement, the workout agreement must be in writing, and should include, at a minimum:
(1) A recitation and borrower’s acknowledgements of all defaults to date;
(2) The consideration for entering the agreement;
(3) Confirmation of the collateral for the SBA loan, which should include the priority of each lien;
(4) An acknowledgement that neither the SBA nor the lender/CDC is waiving any default, right or remedy by entering into the workout agreement;
(5) The forbearance period;
(6) The agreed upon workout option(s);
(7) The events that constitute a default under the workout agreement including the dates by which obligations under the workout agreement must be performed;
(8) The consequences of default under the workout agreement (e.g., bill of sale, or re-acceleration of the note); and
(9) The signatures of the lender/CDC and all obligors on the loan.
See SOP 50 57 2; SOP 50 55.
In addition to those listed above, a workout agreement between a CDC and borrower should also include:
(10) The order in which the funds from payments made under the workout agreement will be applied to the amounts owed on the loan; and
(11) The amount of the reinstated CDC servicing fee, if any, after the loan is returned to regular servicing status.
See SOP 50 55.
How to Make the Workout Agreement Legally Binding
Lenders and CDCs must be aware that a workout agreement only becomes legally binding if the agreement is a bargained-for-exchange, i.e., the borrower must provide something of value (consideration) before or at the same time the lender/CDC receives the benefit of the workout agreement. The consideration provided by the borrower may be, for example, a requirement to:
- Correct loan document errors;
- Waive defenses;
- Release lender liability claims;
- Provide additional collateral; and/or
- Consent to a speedy and inexpensive method of liquidating the loan of the workout fails, i.e., agreeing to waive the automatic stay and turn-over the collateral if the obligor subsequently files for bankruptcy.
See SOP 50 57 2; SOP 50 55.
Regardless of the type of consideration provided, the consideration must be documented in the written workout agreement—as identified by number (2) above.
If the borrower agrees to resume regular payments on the SBA loan in the workout agreement, the lender or CDC should return the loan to regular servicing status. SOP 50 57 2; SOP 50 55.
In addition, the SBA’s prior written approval may be required for some workout options. Lenders and CDCs should review the 7(a) Servicing and Liquidation Action Matrix, the Servicing and Liquidating Actions CDC Matrix, and the following blog posts to determine if the selected workout option or a workout agreement requires the SBA’s prior written approval: SBA 7(a) Loan Liquidation: Which Liquidation Actions Require SBA’s Pre-Approval (Part 1) and SBA 504 Loan Liquidation: Which Liquidation Actions Require SBA’s Pre-Approval (Part 2).
Lenders and CDCs should make a good faith effort to negotiate a workout agreement with the borrower in the event they are seriously delinquent in making SBA loan payments, or the SBA loan is in liquidation status. If you’re an SBA lender or CDC who is considering negotiating a workout agreement with a borrower, the attorneys at Jimerson Birr can help develop a work-out strategy tailored to your unique factual circumstances.
- 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
- SBA Loans: How to Maximize Recovery by Liquidating Real Property
- SBA Loans: How to Maximize Recovery by Liquidating Personal Property
- Assumption, Assignment and Sale of SBA Loans
- SBA Loans: Insurance Requirements and Considerations
- SBA Loans: Offers in Compromise