How should an SBA lender or CDC negotiate a workout agreement with a delinquent borrower?

When an SBA borrower’s loan is in liquidation or goes seriously delinquent, the lender and CDC should have a commercially reasonable and prudent plan to maximize recoveries. Before selling or litigating, a good-faith workout may be appropriate. This article will examine what a workout is and the documents and information needed, how to determine the borrower’s fitness for a workout, workout options, workout contents, and enforceability. If you are the owner of the business, it pays to know how the lender/CDC is going to approach this. Knowing the steps lets you show up prepared.

A workout agreement is an agreement between a lender and a borrower to help the borrower restructure their financial situation, typically their loan, to ensure they are able to continue making payments and avoid foreclosure or bankruptcy. The lender and borrower can also use a workout agreement as a way to work together to maximize recoveries on a loan in liquidation or serious delinquency. A workout lets the borrower cure its default and repay the lender, and gets the lender/CDC the most back.

Decide Whether a Workout Is Even Feasible

None of this is going to happen if the SBA borrower is not cooperative or does not share current financial information. The lender/CDC needs the current financial information to decide whether a workout is even feasible and how to structure one if it is feasible.

First, the Borrower must complete an SBA Form 770 (debtor statement) or provide an equivalent statement sworn under penalty of perjury showing income, expenses, assets, liabilities; the most recent year-end financial statements; and current consolidated statement if there are affiliates.

Second, copies of the borrower’s, and of each of the borrower’s affiliates, federal business tax returns for the last two years, and copies of the borrower’s federal tax returns for two years. If any of the above cannot be provided, explain in writing why.

The SBA workout requirements are documented in SBA SOP 50 57 2, SOP 50 55.

Once the lender or CDC has the financials, they will go through them, look at the loan documents again, then do a site visit. There are four tests that it uses to decide. Competence, cooperation, good faith, and financial and operational viability. Competence means, can the borrower run the business. Cooperation means, is the borrower willing to do everything necessary to try to fix the causes of default. Good Faith means is the borrower being straight with the lender. And financial and operational viability means, can the borrower run the business and keep it alive and well enough to keep up the payments.

If a workout is a possibility, the lender/CDC must immediately negotiate terms. It can’t wait forever. If no agreement is reached within a reasonable time, like 60 calendar days, the lender/CDC has to liquidate the collateral. (SBA SOP 50 57 2, SOP 50 55.)

Workout an SBA Loan

You can workout an SBA loan in a bunch of different ways, more ways than can be listed here. These are the ones that come up the most.

• Forbearance. The lender stops collecting so the borrower can firm up its position and stay out of foreclosure.
• Reinstatement of maturity. If the note was accelerated, revive its original due date.
• Deferment. The lender lets the borrower put off principal and/or interest payments for a set period to get past a cash flow issue.
• Modification. Change repayment terms of the note, for example by lowering the interest rate or extending the maturity.
• Assumption. Someone other than the borrower assumes the loan.
• Lien subordination. The SBA’s lien on its loan is demoted to allow new short-term working capital financing to cut in line.

As part of a workout, a senior lien loan on the same collateral may be kept current, purchased out, or paid off. Borrower may voluntarily sell some or all collateral in commercially reasonable and closely monitored transaction so workout stays commercially reasonable. All net proceeds must be applied to the principal balance on the SBA loan or used to carry out the workout plan.

Agreement Content Requirements

Whatever the two sides agree on, it has to be put in writing, and the agreement should cover at minimum the following.

• A list of each default that the borrower has committed up to date, with the borrower acknowledging each one.
• State what consideration was provided in return for executing the agreement.
• Confirm the collateral on the SBA loan, and the ranking of each lien.
• A statement that by entering into the agreement, neither SBA nor the lender/CDC waives any default, right, or remedy.
• Explain the option(s) the parties agreed on.
• A description of each of the things that the lender or CDC counts as a default under the agreement, as well as the last date each thing is supposed to be done.
• A description of what happens if there is a default under it, such as a bill of sale or a re-acceleration of the note. Signatures of the lender/CDC and every obligor on the loan.

An agreement between a CDC and a borrower should add a couple of extra terms on top of the standard list.

• The order in which payments made under it are credited to amounts owed on the loan.
• Amount of reinstated CDC servicing fee once the loan returns to regular servicing.

These agreement content requirements come from SBA SOP 50 55.

For an agreement to legally bind, both sides have to give up something. The borrower has to put out its part at the latest by the moment the lender/CDC gets the benefit of the workout, or it may not hold up. Its part can take forms such as these.

• Correcting mistakes in the loan documents.
• Waiving defenses.
• Releasing the lender from liability.
• Pledging additional collateral. Whatever form the consideration takes, it must appear in the written agreement, as the content list above calls for.

If you agree in the workout to resume regular payments, your lender/CDC should return your loan to regular servicing status. (SBA SOP 50 57 2, SOP 50 55.)

Caution, here. Some workout options can’t proceed without SBA’s prior written approval. Check SBA’s 7(a) Servicing and Liquidation Action Matrix and Servicing and Liquidating Actions CDC Matrix.