On March 3, 2022, through its PPP Lender Platform, SBA provided informal guidance to lenders on several issues, including whether lenders “should” consider offset as a remedy for borrowers who default on the repayment of PPP loans when they were unable to seek forgiveness. It is important to note that the guidance states that while lenders should consider offset, lenders should only do so if the lender possesses that right. Accordingly, we will examine the issues that lenders face, whether the right of offset exists for lenders on PPP loans, and whether the failure to pursue these borrowers will affect lenders’ 100% loan guaranty at the time of purchase.
The question as published on the Platform states:
“1. Should Lenders Offset Available Funds from Defaulted Borrowers?
If a PPP borrower is unable to seek forgiveness, is asked to pay back the loan on terms, and subsequently defaults, the Lender should make every attempt to collect available funds to reduce the loan balance. If the Lender has the right of offset, it should exercise that right and offset legally available funds. SBA expects Lenders to protect our position and theirs to recover whatever funds they are entitled to.”
Most rights of offset are found in traditional loan documents, notably in a lender’s loan and security agreement. Typically, PPP lenders did not include these in their PPP documents, as PPP lenders possessed no rights to take collateral, obtain loan guarantees, and so on. So, initially, lenders must perform a legal review of its documentation to determine whether that right actually exists by contract. If not, lenders must find another legal basis in order to move forward, as the SBA suggests.
Does the borrower have a depository account with the bank and, if so, do the documents associated with the account provide the right of offset? Is the right to offset clear and applicable to these circumstances? Remember, if a lender does choose to setoff and its documentation does not support a legal action, it could place the bank at risk for a lender liability claim. This is why SBA is careful to point out that only if the lender possesses this right, only then, should it pursue offset.
Another potential factor to consider is how different state laws may impact an offset remedy. What recourse is available following the setoff? For example, lenders with PPP loans in California or Utah may wish to consider whether the one action rule could impact the ability of SBA or Treasury to recover in the event that the setoff resulted in a shortfall. Did the lender obtain SBA’s prior written approval before proceeding?
At this time, it is unclear whether SBA will issue more formal guidance to PPP lenders, and how the issue of offset may affect guaranty purchase. While SBA’s new process, expectations and requirements are being developed, lenders should consider assessing their PPP loan documentation carefully. They should also confer with their counsel to determine if setoff rights are available and document their files with the basis for their decisions, including the reasons they choose to either setoff or not.
For questions regarding the PPP program and other forms of federal relief for small businesses, contact the attorneys at Starfield & Smith at 215-542-7070.