Tip of the Week
SHORT SALES - May the SBA Lender Use this Liquidation Tool?
The current economic environment has brought a number of liquidation tools and terms to the forefront that previously were not utilized much. Among them is the "short sale". A short sale comes about when a piece of collateral - typically real property - may be sold for less than the total of recorded liens outstanding against it. Most often, the shortage is borne by the most junior lienholder, but in some cases, several or all lienholders (and possibly the brokers as well) may be asked to make some concessions in order to accomplish the transaction. Note that only lienholders (secured creditors) are involved. It is not acceptable to utilize any of the sale proceeds to pay unsecured creditors, or provide funds to the borrower or principals of the business.
As an SBA lender, one of the criteria for making 7(a) term loans is often referred to as the "fully secured rule." This requirement to take all available collateral until the debt is "fully secured" can give rise to taking junior liens on real property - commercial, residential or even unimproved land - to satisfy the collateralization requirements. If the subject collateral ends up being part of a loan default that may lead to a foreclosure - whether it is on one of the more senior liens or the SBA loan - and if the property is worth less than the sum of the liens of record, a short sale may be a solution that can provide a better recovery than foreclosing. In the current economic environment, property values in many areas have declined and a distressed sale usually brings about further price compression.
In order for a short sale to be considered, the borrower/obligor(s) must be motivated to cooperate in the liquidation. The borrower (or guarantor) is the party actually offering the property for sale and therefore must be willing to sell based on the market even if it will mean that a deficiency will result for which the borrower and guarantors are liable. The lender(s) must be realistic about the potential recovery. This means that among other factors, the lender(s) must have a recent bona fide valuation of the property to know what it might be worth in the current market particularly in a distressed sale scenario. This potential that the property may not be worth the sum of the outstanding liens mostly impacts junior lienholders. (Older 7(a) loans that may have been made in a piggyback structure with two lenders may also have collateral that is now worth less than when the loans were made. The loan documentation should contain certain restraints on what the senior lienholders can tack on for such things as default interest rates, penalties, etc. which may bring the senior lienholder into the short sale discussion.)
If the borrower (or broker) is able to attract an offer to purchase at a price that is reasonable based on the current valuation and market conditions, then the prospect of a short sale comes into the picture. The borrower (or broker) approaches the lender(s) that would be in a position to get less than the amount of the outstanding lien and lays out the offer in terms of what that lender might receive. From there, the lender has to evaluate the offer versus the potential recovery through a foreclosure - either by a senior lienholder or by the lenders own foreclosure. Assuming the short sale will yield as good of or better recovery than the foreclosure route, this is the point where SBA lenders often ask, "Is SBA approval required?"
Generally, the decision to accept a short sale falls within the authority SBA regulations have delegated to lenders, with a few notable admonitions and exceptions click here for the current Servicing and Liquidation Actions Matrix:
- The lender must clearly document the rationale considered in coming to the determination that accepting the short sale would likely produce the best recovery, at the least cost. This entails a:
- recent valuation/appraisal
- comparison to the sale price offered, and
- calculation of the senior liens and costs for both the short sale and foreclosure options
Essentially, this is where the "reasonable and prudent banking practices" should be substantiated and documented.
- The terms of the short sale cannot involve any compromise of the principal balance owing on the loan. Lenders have the delegated authority to compromise such things as accrued interest and late charges but NO DELEGATED AUTHORITY to compromise the principal owing.
- Acceptance of a short sale without SBA's approval cannot involve an agreement for curtailment of other recovery options that may remain available. The lender does not have delegated authority to release any obligors or guarantors, nor to agree to limit legal means of pursuing recovery. (Obviously, if the borrower or other obligor/guarantor is protected by a bankruptcy discharge, that would bring about a curtailment of actions against that party as it is beyond the lenders jurisdiction.)
To recap, any condition that would involve a compromise of the principal balance owing, release of an obligor/guarantor, or agreement to curtail pursuit of recovery from any party would require SBA's prior approval.
So, back to the bottom line question - "Can a lender agree to accept a short sale on an SBA loan?" Yes, within the limitations described, if the decision is "reasonable, prudent banking practice and consistent with the way the lender manages its non-SBA loans" and the rationale is clearly substantiated and documented.
If you find yourself asking, "Is this within our delegated authority?" it might be time to contact one of us at sbaAccess for guidance or a second opinion.
Take the Right Approach
John Cumbey, Karen McHugh and Brian Burke
SBA Access ©2009 - All Rights Reserved
All content is copyrighted and unauthorized use is strictly prohibited. If you would like to quote any part of this text, email bburke@sbaaccess.com or kmchugh@sbaaccess.com for permission.
Your Subscription:
|
