Lenders should always review SBA’s Servicing and Liquidation SOP when engaging in liquidations of SBA loans. This article will take a high-level look at the changes incorporated into the SOP 50 57 3 (the “SOP”), which went into effect August 1, 2023, that impact liquidation of real property and personal property collateral.
Under the prior SOP 50 57 2, liquidation of real property was required where the value of an individual parcel is $10,000.00 or more, unless there was a compelling reason for not doing so. The latest SOP changes this analysis, stating a lender must liquidate real property collateral that has an individual parcel or aggregate Recoverable Value of $10,000.00 or more unless doing so would create a “Financial Hardship.” See SOP, Chapter 18(A). The SOP defines Financial Hardship as:
An inability to pay for basic living expenses, i.e., the costs that must be paid to obtain the following categories of goods and services necessary for the survival of an Obligor, their spouse and dependents as defined by the most current version of the Collection Financial Standards published by the Internal Revenue Service: (1) food and clothing; (2) out-of-pocket health care expenses; (3) housing and utilities; and (4) transportation. See SOP, Chapter 2 (A)(17).
If properties must be considered in the “aggregate,” lenders may ultimately need to pursue properties that they otherwise would have abandoned. It is unclear if a lender, for example, would be forced to liquidate upon a property that would yield a negative recovery solely because there are other properties with equity that will yield a higher positive recovery. It is also unclear if only properties related to each other (i.e. contiguous parcels) or if any property serving as collateral (i.e. a commercial property and a residential property) would need to be aggregated for this analysis. Even more interesting is that the same sentence also noted foreclosure was required unless it would cause a “Financial Hardship.” Lenders often struggle with the decision to foreclose on a guarantor’s primary residence. This wording may provide a lender with the option to not foreclose, even if the aggregate value surpasses the $10,000.00 threshold, if the property is the guarantor’s primary residence since it may strip the guarantor and their family of the ability to obtain housing. Certainly, if relying upon this language to forego from foreclosure, we would recommend a lender document its credit fully with the analysis of how the financial hardship test was met.
Interestingly, under the new SOP, SBA also allows lenders to forego from liquidation of business personal property collateral if there is a “Financial Hardship.” The new language requires lenders to liquidate personal property that individually or in the aggregate has a Recoverable Value of $5,000.00 or more unless doing so would create a “Financial Hardship.” It seems difficult to imagine a “Financial Hardship” basis not to liquidate business personal property collateral. Since the business personal property collateral relates to a business and not to the assets of the individual, it seems unlikely that liquidation of the same would impact the living expenses of individual owners, we don’t know, at this time, how this new language will be applied in practice.
Other Notable Changes
Many of the other changes in Chapters 18 and 19 were clarifications on principals that were already known or widely applied. However, there are two additional changes that are worth noting.
With respect to real property collateral, there is an addition to Chapter 18(B)(6)(e) that requires that a lender must notify the SBA as soon as the lender learns that a borrower has subleased any portion of a financed property to a tenant engaged in any activity that is illegal on a state or federal level. It also requires that the lender advise of the action the lender intends to take. It is important that lenders be mindful of this requirement as a failure to do so may impact the guaranty moving forward.
As to business personal property, SBA added a section addressing the collection of foreign accounts receivable. Specifically, section (C)(5)(c) requires that lenders must make demand for payment on the foreign account receivables, exhaust their collection efforts on domestic risk mitigation sources such as international letters of credit, but are not required to enforce collection from a borrower’s foreign customers outside of the United States. It is extremely hard in most cases, to collect on domestic accounts receivable, but at least now, lenders with accounts receivable collateral outside of the United States have a clearer understanding of what the SBA expects of them in a liquidation situation.
For questions about liquidation of collateral, please contact Lyndsay Rowland at 267-470-1154.