Defaulting loans frequently find their final resting place in bankruptcy. In most of those cases, collateral is either liquidated by a trustee, sold by the debtor to a third party or abandoned to the secured creditor. When the trustee or the debtor sells collateral in a bankruptcy case, the secured SBA lender enters a very gray area.
SBA lenders are required to enter credit bids when their collateral is sold in a judicial foreclosure. While a bankruptcy sale isn't exactly a judicial foreclosure, such sales share the same basic structure as a foreclosure sale. For example, it is not uncommon for bankruptcy sales to have an auction format that is virtually identical to a judicial foreclosure sale. Even when a bankruptcy sale has a specific third party buyer, the sale must be noticed to all interested parties and the sale is subject to higher and better offers all the way up to the entry of the order approving the sale, just like a judicial foreclosure sale.
Since bankruptcy sales share the same basic features as a judicial foreclosure, the same principles underlying the credit bid requirement also are applicable to bankruptcy sales. SBA lenders, therefore, must decide whether to credit bid in a bankruptcy sale.
If the lender decides to credit bid, it must consider the available equity, the SBA loan balance and the collectability of any deficiency to determine the amount of its credit bid. Obviously, if the amount of the credit bid under this analysis is lower than the proposed bankruptcy sale price, the lender has no issue with SBA compliance. The lender should draft a memo to the file that explains how it arrived at the credit bid amount.
If the amount of the credit bid is lower than the proposed sale price, the lender has some decisions to make. Typically, having the bankruptcy sale go forward is the best outcome for the lender, even if the collateral is being sold at a low price. Bankruptcy sales are quick and final. The transaction costs are relatively low. Plus, the lender avoids taking title to the collateral and expending carrying costs while the lender finds a buyer.
Alternatively, the lender could enter a credit bid for the higher amount. But this option may scare away the potential buyer and eliminate the lender's best chance to liquidate the collateral quickly and painlessly. The lender also could object to the sale without entering a credit bid. The bankruptcy court could approve the sale over the lender's objection (which oddly would be a good result for the lender), but the more likely outcome is the court essentially permitting the abandonment of the collateral to the lender (which the lender could have gotten much more easily and inexpensively if it wanted the collateral).
Finally, the lender also could take no action and permit the sale to go forward. If the lender chooses this course, we strongly encourage the lender to document this decision with a memo to file and retain all the materials supporting its decision. To the lender, permitting the sale to go forward may be the obvious choice that maximizes the recovery. The SBA, however, will be scrutinizing this decision months later when the lender submits its guaranty purchase package or charge off tabs. The SBA will have the benefit of hindsight. If the lender fails to adequately document its rationale for not entering a credit bid at the time, it may face an uphill battle with the SBA as it tries to justify its actions retroactively.
