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Tip of the Week
OIC, RFC, DIL - more odd sounding terms
Last month we provided a TIP about short sales which have become more common and the subject of many lenders questions during the current economic situation. The news media has focused on residential mortgage defaults and the financial woes of very big businesses. The Administration keeps saying that small businesses "need access to capital" but as a few bankers who recently met with the President noted, prospective borrowers that are qualified (in terms that banking regulators would endorse) are not rushing out to borrow money. Very little has been published about how the downturn in the economy has caused a considerable increase in the delinquency, defaults and business failures of existing small business borrowers. These situations do not beg for more money to be loaned (remember - don't throw good money after bad), but rather for lenders to look at workout and liquidation tools that may not have been common in better economic times.
A few other tools/terms that may be appropriate in the course of servicing, workouts and liquidations, which may have become more familiar in recent times include OIC's (Offers in Compromise), RFC's (Release for Consideration) and DIL's (Deed In Lieu).
NOTE: As used in the following discussion, the term obligor means any party that is responsible for payment of the debt. That includes the borrower, all guarantors, etc.
OFFER IN COMPROMISE - This comes up when an obligor (typically a borrower or guarantor) offers something of value in exchange for cessation of any further collection action against them. Let's break down what is involved:
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Obligor - someone (individual or entity) that is legally responsible for satisfaction of the debt. As noted, it might be the borrower or a guarantor.
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Something of value - this is often referred to legally as "consideration" and most likely would be quantifiable and monetary. [Simple cooperation in the liquidation of assets is not likely to be reasonable consideration to substantiate an OIC.] The consideration offered must be reasonable with respect to the offers' capacity - current or future - to satisfy the debt.
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Cessation of further collection action - essentially this means no further action against the party making the offer. An OIC with one obligor does NOT usually extend to other obligors.
The obligor making the offer must provide full and honest financial disclosure regarding assets and income as detailed in SOP 50 51.
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Lenders MUST obtain SBA's approval of an OIC. An OIC does not fall within the unilateral authority which has been delegated to lenders. Since this becomes a legal commitment not to continue pursuit of that particular party (obligor), it terminates both the lenders and SBA's right to take any further collection actions. Therefore, both the lender and the SBA must agree to the terms of the OIC which include evaluation of the party's ability to pay (current and future) and the consideration offered.
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An immediate cash settlement is preferred. However, a reasonable payment plan (i.e. from an income stream not related to the defaulted business) or a future lump-sum payment from some clearly identified future financial event may be considered if appropriately identified and documented.
An OIC may be an option if an obligor has some capacity to repay at least a portion of the defaulted debt and as an alternative to Chapter 7 bankruptcy.
RELEASE FOR CONSIDERATION - This means that a lender (lienholder) will release its interest in some collateral for a reasonable sum (consideration) which is less than the full amount of the debt which the collateral secures. [In a manner of speaking, a short sale falls under this broad category. Click here for the Short Sales newsletter. This may be a tool in situations where the collateral can be liquidated in pieces or where the obligor(s) will attempt to service the remaining debt following liquidation of collateral. Examples of this might be:
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A sandwich shop that has gone out of business and where a deal has been negotiated to leave the assets in place and sell them to a new tenant for less than the balance of the loan (i.e. the new owner is not willing to assume the existing loan). This assumes that the original obligor(s) is working with the lender and landlord to achieve the transaction, as opposed to a scenario where the lender has to take title to the collateral and then resell it.
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A business is still operating but struggling and the borrower is able to sell one or more pieces of equipment or other assets that may not be required to continue operations.
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A situation where multiple pieces of real property support a loan but one or more are not critical to the continued operations of the business and can be sold to reduce debt.
A RFC may be a part of a normal servicing action or may be utilized in a workout or liquidation scenario. The lender must take into consideration the value of the asset (collateral) to be sold and the price to be realized. As with a short sale, the full amount of proceeds should normally be applied as a principal reduction against the debt which the collateral secures.
DEED IN LIEU (of foreclosure) - A DIL technically involves real property collateral where title is transferred by a recorded deed. If the borrower is still working with the lender to resolve a defaulted loan, it may be more cost effective for the obligor to deed the property to the lender and save the expense of foreclosure. However, there are some potential pitfalls and cautions that the lender must be aware of.
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All liens of record follow the property as opposed to a foreclosure in which any junior lines would be expunged. The lender must obtain a "date down" of the title to document the absence or status of other liens.
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The lender still needs to perform its due diligence insofar as a current property valuation and verification that the property has not become environmentally impaired. Obviously, if the property has become impaired, all the prohibitions and potential remedies that apply to an EIP must be taken into consideration.
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The lender and obligor must agree on the sum to be credited against the loan balance in exchange for title to the property (similar to a credit bid as part of a foreclosure).
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The obligor(s) must understand that they will still be responsible for any balance of the debt beyond the amount of the agreed credit to the loan in exchange for title to the property.
A DIL should be very carefully evaluated by the lender. Since all liens and matters of title follow the property, it may not be worth the cost savings as compared to a foreclosure that wipes clean any junior liens.
The current economic environment demands that lenders be more creative and flexible in dealing with loans that are already on their books, while staying within the guidelines of regulatory acceptability. This can be somewhat daunting but you don't have to go it alone. Our clients can call upon their Lifeline agreement when faced with unfamiliar or challenging situations. Make 2010 an easier year when dealing with workouts and liquidations. Lean on the tools of the trade and our expertise in using them.
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.
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