Ultimately, it boils down to leverage, or more specifically, perceived leverage.  When lenders discover that there are material deficiencies in their loan file, they often begin to believe that the borrower has the leverage in the relationship.  Likewise borrowers, through a misapprehension of the SBA rules and their responsibilities thereunder, often believe that they have leverage (because the loan is under-collateralized) or can manufacture leverage (through bankruptcy) over the lender.  An experienced SBA liquidation officer will recognize this scenario and will also know that there are ways to reverse the perceived leverage imbalance.

Lenders should begin by educating their borrowers.  While loan defaults are often very difficult situations for all parties involved, they need not always be adversarial.  Quick intervention by the lender to assess the situation and evaluate the likelihood for a workout are critical steps in an effort to avoid default.  Additionally, educating a borrower about the consequences of defaulting on a federally Guaranty loan (treasury offset against tax refunds and social security, ineligibility for future financing, wage garnishment) can often overcome the resistance of even the most recalcitrant borrower.  By showing the borrower that he/she actually does have something to lose and that, even if the lender goes away, the obligations will remain, is an effective tool to encourage the borrower to work constructively with the lender.  Once the borrower begins to work with the lender in good faith, the lender has the opportunity to correct any deficiencies in its file as part of a larger workout agreement with the borrower.

But what if the borrower (or the principals) file for bankruptcy?  Is there any way to maintain leverage in this situation?  Although the filing of a bankruptcy will often reduce the amount of leverage a lender can exert because the debtor is afforded the protections of the automatic stay, lenders should not assume that the mere filing of the bankruptcy is the end of the story.  Often distressed borrowers will improperly dispose of collateral or will have made misrepresentations in the origination of the loan.  In such instances, there may be grounds to object to the discharge or otherwise contest the bankruptcy.  In these cases, the adversarial proceeding in bankruptcy can be the forum through which a lender can try to address any guaranty affecting deficiencies in its file.

Lenders shouldn't let the circumstances of a default get the better of them.  With early intervention, quality control and a problem solving approach, many situations that would imperil an SBA Guaranty can be mitigated through the opportunities presented in the loan liquidation process.  

For questions regarding how to protect your SBA guaranty, please Ethan at esmith@starfieldsmith.com or at 267-470-1186.   

Reprinted with permission from the National Association of Government Guaranteed Lenders. This article first appeared in the October 2013 issue of In Focus Online, a publication of the National Association of Government Guaranteed Lenders. This reprint contains minor revisions.   

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