How much should I expect to settle with my OIC?
The answer to this is complicated. It is determined by multiple factors, which I will describe below.
Background: When a borrower who has an SBA-guaranteed bank loan defaults, the borrower has the option to seek protection by filing a Chapter 7 bankruptcy (assuming the borrower qualifies…more on that in another post) ) . However, the SBA (and the bank, acting as the SBA’s servicing agent) has the option of allowing the defaulting borrower to make an offer in compromise (OIC) instead of filing for Chapter 7 bankruptcy. You should be aware that an OIC is a PRIVILEGE, not a RIGHT, and the SBA is under no obligation to accept an OIC, and will only do so if the SBA believes it to be a good offer and there is no fraud, concealment, or misrepresentation. How the SBA decides this is often confusing, and it feels like they use black magic to figure it out, and very much depends on the person who is reviewing the file. However, there are guidelines, as set forth in the SBA’s SOP. According to the SBA SOP on OIC,
“The amount pledged must bear a reasonable relationship to the amount that could be recovered in a reasonable period of time through forced collection procedures and must be sufficient to protect the integrity of the SBA loan program.”
So what does this mean? In a nutshell, an acceptable OIC is determined by eight (8) general criteria:
1. Size of deficiency:
The amount of the deficiency is an obvious factor in determining “settlement.” However, while there is a belief that the SBA is “looking” for a 20% recovery, there is really no magic percentage that the SBA will accept. This is because whether the borrower’s deficiency is $150,000 or $1,500,000 only makes sense in the context of the other criteria, i.e., how much can the borrower really afford? What are the borrower’s alternatives?
2. Liquidated value of the borrower’s assets in the event the borrower seeks protection in Chapter 7 Bankruptcy (BK)
This is an obvious alternative to an OIC for the borrower. This is a calculation that must be done and it is very important to present it to the bank and/or the SBA. If the borrower has limited exposure in a BK filing, that will have an impact on how the SBA views an OIC…but the borrower should keep in mind that even if they have NO liability in a BK filing, and their personal collateral would be canceled completely, the SBA may STILL require a significant and substantial OIC settlement amount, depending on the borrower’s net worth and ability to pay.
3. Borrower’s net worth if NOT seeking BK protection.
Many delinquent borrowers assume that “exempt” assets do not account for SBA thinking when it comes to an OIC. This is not correct. Although IRAs and 401Ks are “exempt” from consideration in a BK filing, the SBA will still consider these assets when examining an OIC. Why? Because the OIC is a PRIVILEGE … and, in many cases, the SBA official feels that the borrower must use his or her assets, including exempt assets, to demonstrate a bona fide OIC.
4. Recovery if SBA seeks wage garnishment for five (5) years
The SBA will also consider the purchasing power of the guarantors. We recently spoke with a high-powered attorney who was ~$600,000 in arrears. The SBA was seeking $300,000 from him, even though he filed BK, his exposure was less than $30,000. Why? Because he was earning $250,000+ annually. They figured if they garnished her wages (which they could do if she didn’t file BK) they would collect $300,000 over five years. In this case, the SBA got it wrong: the borrower applied for BK.
5. The borrower’s “desire” to avoid bankruptcy
This is a confusing calculation, but I advise my clients that filing a BK has a “hidden” cost. Operating in the business world is complicated when a borrower applies for BK, and these complications can cost real money over the 10 years that a BK is reported on a credit report. I estimate the cost to be between $75,000 – $125,000. Put another way, if the borrower can afford an OIC deal for less, it’s a good idea to settle. However, if the settlement cost is higher than that, as in the case of the attorney I mentioned above, then the borrower should seek protection through a BK.
6. Structure of the Offer
Many borrowers ask us whether or not they can set up a Payment Plan for their OIC. The simple answer is yes, but… brace yourself, the amount the SBA will require under the terms of a payment plan is typically higher than if the borrower can make a one-time lump sum offer. The reason is simple: Many borrowers on repayment plans do not honor those plans. The SBA understands this and is requiring a higher settlement amount to reflect the increased “risk” that they will not receive all of their payments.
7. Other factors: health, age, unusual circumstances
The SBA will take into account “other” factors such as age, health, etc. For example, if a borrower is 65 years old, the hidden cost of a BK is negligible since the value of a clean credit report is meaningless to most people approaching retirement. Similarly, significant health issues affecting a borrower will influence SBA’s consideration of an OIC. Other factors that could influence the SBA would be a sick child, a divorce, or a sudden job loss.
8. Administrative costs
This sounds trite, but the SBA and the bank involved are large and relatively inefficient bureaucratic entities. As such, they have operating expenses, and in order for them to turn the wheel of progress and actually process an OIC, the offer must be enough to get them interested. For a borrower with NO exposure to a BK, NO other collateral, and NO liens on personal property, this figure is relatively modest…perhaps as low as $10,000 – $15,000. If there are liens on personal property, the bank must now spend resources to remove these liens (legal fees), which can increase the cost by another $10,000 or more.
In the end, trying to estimate what the cost of liquidating a defaulting borrower’s OIC will be is an exercise based on multiple factors and criteria. And there is no single answer: each situation is different and unique.
