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April 13, 2016

Best Practices: When Between a Rock and a Hard Place, Facts Matter!

by Ethan W. Smith

Most SBA lenders are aware of the rule that they cannot request that the SBA purchase a loan guaranty until the loan has become at least 60 days past due. 13 CFR §120.520. However, a difficult question can arise for lenders when a borrower has defaulted under the note, but continues to stay current on payments. Can the lender enforce its rights under the note, or must it wait until the borrower misses 2 payments before it can take action? A close reading of SOP 50 57 2 can provide some helpful guidance on this point.

The SOP provides that SBA “Lenders with a non-SBA guaranteed loan portfolio may decide whether to accelerate the Note based on their own policies and procedures for similarly-sized non-SBA guaranteed commercial loans.” SOP 50 57 2, Chapter 14, Paragraph B.1. This would lead most lenders to conclude that they can accelerate for any default which would allow acceleration of a similarly sized conventional loan. However, lenders should be careful not to act too hastily, as the SBA provides additional clarification in a note to this section which provides: “A Lender may not request guaranty purchase based solely on a non-payment default such as failure to provide financial statements in a timely manner.” Id.

So, what is a lender to do? It may seem that lenders are between the proverbial rock and a hard place; on the one hand, being allowed to accelerate a note according to their conventional loan policies and procedures, but on the other hand, being admonished not to push borrowers into liquidation for purely “technical” reasons. For lenders looking for options, an examination of the relevant facts is in order.

SBA is clear that lenders should not accelerate for purely technical reasons (i.e. failure to provide financial statements, tripping a financial performance or other reporting covenant, or other non-material, non-payment defaults). Acceleration of a note on these grounds is contrary to the SBA’s stated goal of “helping entrepreneurs start, build and grow viable small businesses.” SOP 50 57 2, Chapter 1, Paragraph C. However, there may be some defaults that, while “technical” in nature, may be of such importance so as to warrant a lender’s acceleration of the note and pursuing its remedies, notwithstanding the fact that no payments have been missed. Such defaults may include material non-payment defaults such as: conversion or other unauthorized disposal of SBA loan collateral; borrower engaging in a pattern of fraudulent conduct designed to obstruct or mislead the lender; borrower’s fraudulent misuse of loan proceeds, or other fraudulent actions of the borrower (all of which would also warrant a referral to the OIG). These types of defaults speak to a competing interest of the SBA: “maintaining the integrity of the loan program…” Id.

In such cases, Lenders may be justified in accelerating their notes, thereby causing the loan to become 60 days past due if not paid within that time frame and entitling the lender to request a purchase of the guaranty. In such situations, it is imperative that lenders thoroughly document their files regarding the reason for the acceleration and how acceleration of the note protects the interests of both the lender and the SBA, as well as the integrity of the SBA loan program.

Accordingly, SBA lenders confronted with serious non-payment defaults are not necessarily without recourse. By examining the facts of each case to determine the seriousness of the non-payment defaults, Lenders may be able to justify acceleration of the note and liquidation of the collateral in certain circumstances. Lenders that pursue this option must clearly document their files to ensure that the SBA will clearly see the Lender’s reasoning and why acceleration was necessary to protect the interests of the SBA.

For more information on servicing and liquidating SBA Loans, contact Ethan at esmith@starfieldsmith.com or at 267-470-1186.