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 a bank loan, guaranteed by the SBA, defaults, the borrower has the option of seeking protection by filing a Chapter 7 bankruptcy (assuming the borrower is eligible…more on that in another post). ) . However, the SBA (and the bank, which is 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 not required to accept an OIC, and will only do so if the SBA believes it is a good offer and there is no fraud, concealment, or misrepresentation. The way the SBA decides this is often confusing, and it feels like they are using black magic to figure it out, and it depends a lot on the person reviewing the file. However, there are guidelines, as set out in the SBA SOP. According to the SBA SOP on OICs,
“The amount committed must bear a reasonable relationship to the amount that could be recovered in a reasonable period of time through enforcement procedures and must be sufficient to protect the integrity of the SBA loan program.”
So what does this mean? Simply put, 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 the “liquidation.” However, while there is a belief that the SBA “seeks” to get a 20% recovery, there is actually 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, ie, how much can the borrower actually repay? 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 on a BK filing, that will impact how the SBA views an OIC…but the borrower should keep in mind that even if they have NO liability on a BK filing, and their personal guarantee would be cancelled. in full, 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 borrowers in default assume that “exempt” assets disregard 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. Because? Because the OIC is a PRIVILEGE…and, in many cases, the SBA officer feels that the borrower must dip into his or her assets, including exempt assets, to demonstrate a bona fide OIC.
4. Recovery if the 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 delinquent. The SBA was seeking $300,000 from him, even though he filed BK, the exposure of him was less than $30,000. Because? Because he was making $250,000+ annually. They figured that if they garnished his wages (which they could do if he 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 the 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 lawyer 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 structure 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 repayment plan is often higher than if the borrower can make a single lump sum offer. The reason is simple: many borrowers on payment plans don’t honor those plans. The SBA understands this, so it is requiring a higher settlement amount to reflect the greater “risk” that they will not receive all payments.
7. Other factors: health, age, unusual circumstances
The SBA will consider “other” factors such as age, health, etc. For example, if a borrower is 65, the hidden cost of a BK is negligible as the value of a clean credit report is meaningless to most people nearing retirement. Similarly, significant health problems affecting a borrower will influence the 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 hackneyed, 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 spin the wheel of progress and actually process an OIC, the offer has to 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 number 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 OIC liquidating a defaulted borrower will be is an exercise based on multiple factors and criteria. And there is no single answer: every situation is different and unique.