An SBA offer in compromise is, put simply, an offer to pay a debt for less than the full amount. Normally, the offer will be used when the SBA is pursuing a business loan and the business has gone out of business, and the collateral has been sold. In other words, the offer is designed to address the situation where you still owe a large balance on an SBA loan and you have no good alternative way to pay it. You propose to pay part of what you owe, and the SBA treats the debt as settled. Say you agree to pay $50,000, and in exchange the SBA waives the remaining balance on the loan.
There are of course requirements to this offer. One such requirement is that the amount cannot just be a random number, but must bear a reasonable relationship to what SBA could get back from you through enforced collection in a reasonable amount of time. In addition, this amount must be sufficient to protect the integrity of the SBA program. As a general rule this amount should be over $5,000 unless that amount is a financial hardship for the borrower. In most cases, this amount is paid in a lump sum on a specified date (generally within 60 calendar days after the offer is approved). In some cases, installments are allowed if it will maximize the amount SBA can recover.
Note that you do not submit an offer to the SBA directly. Submit the offer to the lender or CDC, and if it agrees to your offer, it will send the offer to the SBA for approval. If the offer is approved, your balance will be classified as “Compromise/Closed,” and you will no longer owe anything on the balance. The one exception is a compromise obtained through fraud, misrepresentation, or a mutual mistake of fact. And there is no guarantee that your lender will accept your offer, nor that the SBA will approve it.
Offers Are Appropriate
Offers are appropriate when the collateral has been liquidated, but the lender or CDC still has a balance owing on the loan. That usually means the business has closed. You can also make an offer while the business is still operating if there is an issue of the survival of the business. An offer in compromise should not be used for temporary cash flow problems.
Beyond that, the loan has to be in liquidation status. The borrower must not be in bankruptcy proceedings, unless expressly permitted by the court. And the full balance has to be out of reach for a concrete reason: you can’t pay it in a reasonable time, the SBA cannot collect in a reasonable amount of time through enforced collection actions, the cost of collection would exceed what could be recovered, there is a substantial risk of the SBA losing in court, or your special circumstances, such as an illness, make collection of the amount owed a financial hardship. Collection of the amount owed must not be prevented by a legal defense, such as bankruptcy discharge or the Statute of Limitations. Finally, you cannot have engaged in fraud, misrepresentation or other financial misconduct.
Settling while the doors are still open is harder. Your offer must be necessary to maintain the viability of your business and avoid its closure. Your offer must be part of an overall debt restructuring and involve all creditors, and the terms for each creditor’s secured and unsecured debt must be set out in a written agreement that all of them sign. Put bluntly, if you can’t get all your creditors on board and in a written agreement, you can’t do a going concern compromise. You also must pass the SBA’s “feasibility test” for a successful workout, and the SBA must be treated fairly compared with other creditors.
Then Comes the Paperwork
Then comes the paperwork. The Form 1150 offer has to say how you would fund it, and explain any special circumstances. You sign it under the federal false statements statute, 18 U.S.C. § 1001. Next is SBA Form 770, and that is a real pain. On the surface it looks like a fairly simple exercise to list the assets, liabilities, income and expenses, but it is signed under penalty of perjury. Include the last year-end financial statements for any going concern, plus a current consolidated statement if you have affiliates. You will also hand over two years of personal federal tax returns (or an explanation of why you can’t) with a signed IRS Form 4506-T, and two years of business returns for any going concern and affiliate. Explain the surrounding circumstances to the best of your ability. Check the forms to make sure the numbers match up. Do not try to fake a financial condition you do not have.
The Lender Will Scrutinize Your Finances
That matters because the lender will scrutinize your finances and won’t take your word for anything. The lender reviews the financial information you provide to support the offer, and makes a good faith effort to verify it. At a minimum it pulls a current credit report, compares it with your past and current financials, and investigates any discrepancies. A balance sheet that looks good on paper is one thing, but if you cannot back it up it will simply harm your position. Then the lender estimates what it could actually recover from you through enforced collection. That includes any collateral that the lender has not yet sold or liquidated, your exemptions under state and federal law, your non-exempt assets that the lender never took, your current and future income, the risk of litigation, legal and administrative costs of collection, the amount of time it will take to collect, and whether you have or may have hidden or fraudulently transferred any of your assets.
Your cooperation can help: the lender may consider whether it increased the overall recovery during the liquidation. If your offer was made in good faith but is too low, the lender should come back with a counteroffer rather than simply walk away. An offer or counteroffer the lender considers unacceptable never goes to the SBA.
The lender must get the SBA’s written approval before the lender can enter into a compromise agreement. A lender that skips that step risks losing its 7(a) guaranty. After approval, the lender applies the compromise amount to the principal balance, releases the loan documents once it has received the full compromise amount, and, if there is no one else to collect from, such as another borrower on the loan, files a wrap-up report so the remaining balance can be charged off.
Offers in compromise are not quick, and the paperwork is unforgiving. However, they can provide business owners with much-needed relief in certain situations.
