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July 15, 2015

Best Practices: Early Lender Response on Borrower Defaults

by Starfield & Smith

When an SBA borrower begins to struggle to make its loan payments, the lender must consider the SBA’s requirements in determining how to proceed. Under SOP 50 57, Chapter 14,

“Lenders should make a good faith effort to help delinquent Borrowers bring their loans current. But, when a payment default cannot be cured, the Note should be accelerated, demand made on the Obligors, the loan classified in liquidation, the SBA guaranteed portion re-purchased from the secondary market, and a Liquidation Plan prepared and implemented without further delay.”

These instructions often seem contradictory; the Lender should make a good faith effort to help the borrower, but must also decide when a default cannot be cured and then proceed with acceleration and liquidation.

One starting point for consideration is whether the borrower can satisfy the SBA’s feasibility test, as set forth in SOP 50 57, Chapter 16, which is intended to determine whether a borrower is a good candidate for a workout. After obtaining the financial information that the SOP requires, including financial statements and tax returns, the lender should:

“conduct a site visit if feasible, and ascertain whether the Borrower is: (1) competent, i.e., has the necessary technical and management skills to turn the business around; (2) cooperative, i.e., willing to take the necessary action to address the problems that caused the default; (3) acting in good faith, and (4) financially and operationally viable.” (SOP 50 57, page 90).

While evaluating the feasibility of the borrower’s business, however, and ascertaining whether the borrower will be able to service the loan on an ongoing basis, the lender should not lose sight of the SBA’s other requirements, and be sure that it is protecting itself in case it must put the borrower into default.

For example, if the lender agrees to a deferment, it must consider whether investor approval is required. Under SOP 50 57, Chapter 7, if a loan was sold on the secondary market, the repayment terms of the Note may not be changed unless the guaranteed portion of the loan has been purchased by SBA or the investor’s written consent has been obtained (except for a one-time deferment that does not exceed a continuous period of three monthly installments).

In addition, it is crucial for the lender to perform a timely site visit – within 60 calendar days of an uncured payment default, within 15 calendar days of an event that causes the loan to be classified in liquidation status, and in either event sooner than the specified time if the collateral could be removed, lost or dissipated (note that the SBA generally considers the site visit to be performed “within” a period of time to be after the triggering event occurs, so a site visit should be performed after the default, even if the borrower was struggling before the default). Absent a timely site visit, if collateral is removed, lost or dissipated, the lender is likely to face repairs, or possibly a denial, of its guaranty, based on the value of the collateral that the lender is unable to liquidate.

While working with any borrower in distress, the lender should also reexamine its file and identify any deficiencies. This is often an optimal time for enlisting the borrower’s cooperation and addressing any such deficiencies in the loan file.

Whenever a borrower struggles to meet its obligations, the lender should always review and address the requirements of SOP 50 57. By anticipating a default while working with the borrower to keep the loan performing, the lender will protect itself while assisting the borrower.

For more information on loan default and guaranty purchase related matters, please contact Amy at 267-470-1187 or at abrownstein@starfieldsmith.com.