Let’s say that you own a small business and you are hopelessly behind on your small business administration loan. You probably think that the government never settles. Well, surprisingly, the Small Business Administration does have a formal settlement process known as an offer in compromise. But this negotiation typically doesn’t happen until after the business has closed and the collateral has been liquidated and the lender and SBA agree to settle.
When a business has been unable to pay back the full balance of an SBA loan, even after having liquidated all of the collateral, they can use an offer in compromise to settle their debt for less than the amount that is due. In this case, you would pay the SBA a portion of what you owe and the SBA would consider the debt as settled. There are no guarantees that the SBA or lender will accept an offer you submit.
There are rules about how much you offer. The amount of the offer must bear a reasonable relationship to what SBA could reasonably recover within a reasonable time by enforced collection of the debt. It must also satisfy the goal of preserving the integrity of the SBA program. In most cases the offer in compromise amount will be more than $5,000 unless to do so would cause economic hardship. The offer generally should be for a lump sum within 60 days of approval but in some cases, for installments, if this would serve to increase the amount SBA could recover.
You don’t send your offer to the SBA, you send it to the lender (or to the CDC, if yours is a 504 loan). If the lender agrees to your offer, it sends the offer to the SBA to see if they agree. If the SBA agrees, the loan is marked “Compromise/Closed”, and you aren’t on the hook for the rest of the balance (unless you got a compromise through fraud, misrepresentation, or mutual mistake of fact.)
You can come up to the table with an offer if: a) the business is closed and all of the collateral is liquidated and/or b) the business is still in operation but at risk of closing. It is not sufficient that the business just faces temporary cash-flow problems.
Timing is only part of it. The loan must be in liquidation status, the borrower cannot be in bankruptcy unless the bankruptcy court sanctioned the compromise, and it has to be clear that the full balance can’t be recovered, either because the borrower is unable to pay it in a reasonable period of time, or the creditor couldn’t enforce the claim in a reasonable time, or the expense of collection wouldn’t be justified. It can also be because there is significant litigation risk associated with the SBA being able to win in court because of legal issues or disputes over facts, or because of special circumstances (such as illness meaning payment would be a financial hardship). Collection also can’t already be barred by a valid legal defense (such as bankruptcy discharge or statute of limitations), and it only works if the borrower hasn’t committed fraud or made misrepresentations, or otherwise behaved badly financially.
If your business is still open, it’s still “a going concern” and there’s extra stuff you have to do to get an SBA offer in compromise. You have to prove the compromise is necessary to prevent closing down the business. And that you can come out on the other side successful, the “feasibility test.” And that this is all part of a restructuring plan where ALL your creditors participate. Everyone who’s owed money has to sign a written agreement. And you can’t discriminate against the SBA: the SBA gets treated pretty much the same as the other creditors.
SBA Form 1150
Then comes the paperwork. You’ll need SBA Form 1150 or a written offer that does the same thing. It needs to be signed under penalty of making false statements (18 U.S.C. 1001), and explain where your money comes from and any special circumstances, such as illness. The other form is SBA Form 770, the financial statement. It needs to be signed under penalty of perjury and show your assets, debts, income and expenses. You will also have to hand over your personal federal tax returns for the past two years, or if they’re not available, you’ll need to explain why, and sign IRS Form 4506-T. If you run a “going concern” business, you need to provide the past two years’ business tax returns, and if you have any affiliates, you’ll also need to provide the business tax returns for those affiliates. If you are a going concern business, you also need to provide your financial statements from the end of last year. If you have affiliates, you need to provide consolidated financial statements.
Check Your Financial Info with Independent Sources
Once your offer arrives, the lender isn’t supposed to ignore your financial statement and accept it at face value. They’re supposed to do a “good faith effort” to check your financial info with independent sources, including at least a current credit report, compare the data in your application to the credit report, investigate any discrepancies, and document their verification efforts in the loan file. The lender has to make a reasonable estimate of what it could collect by forcing collection in a reasonable time:
- value of any remaining collateral not already sold;
- exemptions under state and federal law;
- non-exempt assets not pledged as collateral;
- present and future income of the debtor;
- litigation risk, legal and administrative costs;
- time required to collect;
- probability that assets have been hidden or transferred fraudulently.
It may also take into account whether your cooperation during the liquidation increased the overall recovery. If the borrower makes an offer that is “too low”, but made in good faith, the lender should try to negotiate an amount acceptable to both parties by submitting a counteroffer to the borrower. Any offer or counteroffer, however, that is deemed to be unacceptable is not sent to the SBA.
Your bank can’t sign a compromise without SBA’s prior written approval – otherwise it risks losing the 7(a) guaranty. If SBA approves, the bank applies your payment to principal, executes a release of the loan documents when it receives the compromise amount in full, and files a wrap-up report if there’s no one else to collect from, so the rest of the balance is charged off.
So, can SBA debt be negotiated? Yes, but it isn’t something you do over the phone with SBA. It is a formal process with rules. A lot of paperwork. And you have to sign it all, under penalty of law. The lender has to agree to it. Then the SBA has to say OK in writing. A temporary cash flow problem won’t cut it. And if you lie, it will all be taken back.
