How much should I expect to settle on 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, goes into default, 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, who acts as the SBA’s servicing agent) has the option of allowing the defaulted borrower to make an Offer In Compromise (OIC) in lieu of filing Ch 7 bankruptcy. The borrower 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 feels it is a good offer, and there is no fraud, concealment or misrepresentation. How the SBA decides this is frequently confusing, and feels like they use black-magic to figure out, and is very dependent on the individual who is reviewing the file. However, there are guidelines, as laid out in the SBA SOP. According to the SBA SOP on OICs,
“The compromise amount must bear a reasonable relationship to the amount that could be recovered in a reasonable amount of time by enforced collection proceedings and must be sufficient to protect the integrity of the SBA loan program.”
So what does this average? Simply put, an permissible OIC is determined by eight (8) general criteria:
1. Size of the deficiency:
The amount of the deficiency is an obvious factor in calculating the “settlement”. However, while there is a belief that the SBA “looks” to acquire a 20% recovery, there is truly no magic percentage that the SBA will accept. That’s because whether the borrower’s deficiency is $150,000 or $1,500,000 is only meaningful in the context of the other criteria – namely, what can the borrower truly pay? What are the borrower’s alternatives?
2. Liquidated value of the borrowers assets should the borrower seek protection in Chapter 7 Bankruptcy (BK)
This is an obvious different to an OIC for the borrower. This is a calculation that must be done, and is very meaningful to present to the bank and/or SBA. Should the borrower have limited exposure in a BK filing, that will have an impact on how the SBA views an OIC… but the borrower must keep in mind, that already if they have NO liability in a BK filing, and their personal guarantee would be completely discharged, the SBA may nevertheless require a meaningful and substantial OIC settlement amount, based on the Net Worth of the borrower and their ability to pay.
3. Net worth of the borrower if they do NOT seek BK protection.
Many defaulted borrowers assume that “exempt” assets do not factor into the SBA’s thinking when it comes to an OIC. This is not correct. already though IRAs and 401Ks are “exempt” from consideration in a BK filing, the SBA will nevertheless consider these assets when examining an OIC. Why? Because the OIC is a PRIVILEGE… and so in many situations the SBA officer feels like the borrower should dip into their assets – already exempt assets – to demonstrate a good faith OIC.
4. Recovery should the SBA seek wage garnishment over five (5) years
The SBA will also consider the earning strength of the guarantors. We recently spoke with a high-powered attorney who was in default on ~$600,000. The SBA was seeking $300,000 from him, already though if he filed BK his exposure was less than $30,000. Why? Because he earned $250,000+ yearly. 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 year. In this case, the SBA guessed wrong – the borrower filed for BK.
5. Borrower’s “desire” to avoid Bankruptcy
This is a fuzzy calculation, but I advise my clients that filing a BK has a “hidden” cost. Operating in the business world is complicated when the borrower files for BK, and these complications can cost real money over the 10 years that a BK is reported on a credit report. I calculate that the cost is between $75,000 – $125,000. Stated another way, if the borrower can provide an OIC settlement for less, it is 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 by 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… be prepared that amount that the SBA will need under terms of a payment plans are typically higher than if the borrower can make a single lump-sum offer. The reason is simple: many borrowers on payment plans default on those plans. The SBA understands this, and so demands a higher settlement amount to mirror the increased “risk” that they will not receive all the payments.
7. Other factors – health, age, uncommon circumstances
The SBA will take into consideration “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 for most people nearing retirement. Likewise, meaningful health issues affecting a borrower will influence the SBA’s consideration of an OIC. Other factors that might 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 both large, comparatively inefficient bureaucratic entities. As such, they have operating expenses, and for them to turn the wheel of progress and truly course of action an OIC, the offer must be enough to get them interested. For a borrower with NO exposure in a BK, NO other collateral, and NO liens on personal character, this figure is comparatively modest… maybe as low as $10,000 – $15,000. If there are liens on personal character, now the bank must expend resources to have these liens removed (legal expenses) which can excursion the cost up another $10,000 or more.
In the end, trying to calculate what a defaulted borrower’s OIC settlement cost will be is an exercise based on multiple factors and criteria. And there is no single answer – every situation is different and rare.