In many states, it is standard practice for an SBA lender to ask a loan guarantor to pledge their home as collateral in connection with their unconditional guaranty. If the business loan you guarantee goes into default, your homestead could be at risk of foreclosure. However, the SBA may not always urge a lender to foreclosure on your home, even if the SBA and the SBA Lender have a legal right to do so. Here are a few factors that may impact this decision:
Do you have a first mortgage on your home ahead of the SBA loan? This may help you.
The general rule in property law is that liens have priority in the order that they are filed in the county records office. This is known as the first in time, first in right rule. Based on this principle, a recorded interest has priority over later recorded interests. If your first mortgage is ahead of the SBA loan, it will make foreclosure less attractive to the SBA Lender since foreclosure proceeds must first be applied to payoff the first mortgage entirely, plus the costs of foreclosure before the second mortgage holder receives anything.
If your home equity is zero or very low, it may be that the SBA lender will choose to do nothing for now and wait hoping the home will increase in value over time. In many cases, if this occurs, a foreclosure may not be initiated for years and then only if the value of your home has substantially increased and some factor has brought this to the attention of your SBA Lender or the SBA.
What is Home Equity?
Home equity is the market value of a homeowner’s unencumbered interest in their real property, that is, the difference between the home’s fair market value and the outstanding balance of all liens on the property. For example, if your home is worth $225,000 and you have a first mortgage to Bank X for $100,000, then you have $125,000 of “Equity” in your property and, in an SBA default situation, that might tempt the SBA Lender or the SBA to foreclose. However, if you add a second mortgage of $75,000, then you only have $50,000 of equity in your property and, in a foreclosure setting, this may not be enough for the SBA Lender (in a third position behind your second mortgage) to foreclose. Be sure to review all your mortgage debt with your attorney if you are discussing the consequences of an SBA loan default.
Can I make the SBA or the SBA Lender an Offer to Release My Home as Collateral?
Yes, you can make the SBA Lender an Offer in Compromise to settle your total liability associated with your personal guaranty or you can just make an offer for the release of the lien on your home. But, use caution. If you obtain a release of SBA Lender’s lien on your home without also completely settling your liability under your personal guaranty, you might later be sued by the SBA Lender. If the SBA Lender obtains a judgment, and then places a judgment lien on you real property, your home may be at risk all over again.
Handling the release of an SBA lien on your home correctly may require professional assistance. It is important to consider this action as a part of your overall strategy. In many cases, it may be possible to combine the release of the lien on your home as part of your complete offer in compromise settlement package. But, many variables can affect the outcome, so be sure to discuss your goals completely with your attorney and/or CPA.
We frequently talk to people who have filed bankruptcy in an effort to discharge the remaining balance due under the SBA Note. While the debt to the SBA may be dischargeable under the bankruptcy code, in most cases, the lien is not (lien stripping in a Chapter 13 with the lender/SBA in a junior lien position where said lien has a zero value being a possible exception).
Choose your Bankruptcy Attorney Carefully.
If you are contemplating bankruptcy instead of an SBA offer in compromise, our firm encourages you to visit with a seasoned consumer bankruptcy attorney that will take the time to walk you through the facts of your case and address issues related to what debts will and won’t be discharged and how the liens on your property may or may not be affected by your filing. And, these answers should come from your bankruptcy attorney, not his or her paralegal.
I filed bankruptcy. What do I do about the SBA lien on my home?
The SBA may consider a release of liens on real or personal property collateral for consideration. In cases where a bankruptcy has been filed, a formal offer in compromise may not be necessary since the underlying Note has been discharged in the bankruptcy proceeding. In many cases, a Lender with sufficient authority can work with a borrower or guarantor without direct SBA involvement; whether this is the case or not will depend on a number of variables.
When reviewing a case for granting a lien release two factors control:
(i) the amount of consideration (your offer) received must be approximately equal to or greater than the Recoverable Value of the collateral; and
(ii) the release of the lien must not jeopardize the ability to maximize recovery on the loan (in the case of a prior bankruptcy filing, there will be no further recovery).
How do I know what my property is worth?
Generally, an appraisal from a qualified/licensed real estate appraiser will be necessary. When dealing with banks, more often than not, they will employ an appraiser and schedule a visit to your home. However, in many cases dealing directly with the SBA will produce an altogether different result; SBA tends to rely on online services such as Zillow. And, in some cases, borrowers or guarantors may feel that Zillow’s valuation does not reflect the current value of their home. In order to convince the SBA otherwise, you will need a professionally prepared appraisal.
Can I pay over time and have my lien released?
In our experience, lenders and the SBA are interested in lump sum offers. A lender usually reserves almost unfettered discretion in this area under the loan documents, so anything is possible. But, in our view, the cleaner and simpler the deal the better. Under ordinary circumstances, borrower and lender (or SBA) can negotiate the amount of cash consideration to be paid for the lien release and the release will be provided after the payment has been made. This transaction is final.
Are there reasons why the lender or SBA might not agree to a lien release?
Yes, lenders and the SBA may feel your offer is too low or may be aware that the market price for your property is expected to increase in the near future. Remember that in order to sell the property in the future, existing liens must be paid off. So, the sit and wait strategy is sometimes employed. There are also many other factors that lenders and the SBA consider, but in our experience a clear trend in the local real estate market is a major factor. Its worth mentioning that if property values are dropping then a lender or the SBA may be more likely to consider a lien release. Therefore, appraisals also serve to inform and educate lenders and the SBA on current trends that could work in your favor during negotiations.
Can I settled with the SBA instead of filing for Bankruptcy?
The SBA, much like the IRS, has a program called an “Offer in Compromise”. This program may allow for the settlement of the debt, no matter how great, for less than the demand amount in your 60-day letter from the agency. However, in order for this program to be applicable, the SBA must find that payment in full would cause a hardship on your family. But, in our experience, this is often true. Many business owners deplete savings, retirement and almost all available cash in an effort to save their business; this often leaves very little once the doors actually close. If you would like more information about the SBA Offer in Compromise program, please review SBA Offer in Compromise materials on this site.
What is a CDC/504 Loan?
The Small Business Administration (SBA) has a loan program know as the “504 program”. The 504 program helps small business owners purchase commercial real estate (e.g., a hotel/franchise or a small office building). Unlike the 7(a) program that incentivizes private lenders to help small business by partially guaranteeing their loans, the 504 program is a hybrid.
Under the 504 program, the the borrower has two loans: one to a private lender and another to a Certified Development Company (CDC). In such scenarios, the real estate is financed by a conventional loan that is not guaranteed by the SBA; this lender covers 50% of the project. The second player is the CDC, a nonprofit company acting as a conduit for SBA funds, and it funds 40% of the project; this loan is 100% guaranteed by the SBA. The remaining 10% of the project is funded by the borrower.
In a CDC/504 Loan, the private lender takes a first position lien on the real estate while the CDC takes the second position lien. In the event of a default, a short-sale or foreclosure will usually result in proceeds sufficient to pay off all or nearly all the private lender. I say “usually” because as some of my colleagues have pointed out, real estate in some markets has taken a nose dive.
I am current with the bank, but months behind with the CDC, why aren’t they foreclosing?
The short answer to the question is that your first lender is not in monetary default, so they are unlikely to foreclose on the basis that you have defaulted another obligation, although in some cases breaching loan covenants and representations and warranties will stir a bank to action.If the second lien holder files a foreclosure action, the sales proceeds must still be applied in order of lien priority. Therefore, if the CDC sees that it will not reap enough to make foreclosure worth it, then why foreclose at all. In many cities market conditions for certain types of commercial real estate are so bad that the CDC simply cannot foreclosure. This posture is then assumed by the SBA once the guarantee to the CDC is paid and the SBA assumes actual ownership of the Note and Security Agreement plus the attendant personal guarantees.
If the SBA won’t foreclose, why do I need to worry?
Although foreclosure may not be in the cards for you, that is not to say the CDC won’t sue the borrower and/or pursue the guarantors. And, if they choose not to do so, the SBA still can once the guarantee payment to the CDC has been made. An SBA Offer in Compromise (OIC) may be an available option. If initiated early an OIC can sometimes provide hapless guarantors an opportunity to walk away from a mountain of debt for a relatively modest percentage of what was owed. But, a settlement is not foregone conclusion. The SBA will expect you to dig deep and make a serious offer, otherwise a quick rejection often follows.
Remember, if the SBA cannot collect, then they will send the bad debt to the Treasury Department for collection where a 28% one-time collection fee will be added to the debt. In addition the Treasury Offset Program (TOP) will begin to review the file and take action, including tax refund intercept and offset of social security benefits if you are already receiving them. And, if that is not enough, and you are gainfully employed, you will likely be the recipient of a federal wage garnishment order that can remain in effect continuously until the debt is paid in full.
It is settled law that state limitations statutes are relevant in determining a claim’s viability at the time the federal agency acquires the claim. If the state statute of limitations has expired before the government acquires a claim, that claim is not revived by transfer to a federal agency. FDIC v. Former Officers & Directors of Metro. Bank, 884 F.2d 1304, 1309 n. 4 (9th Cir.1989), cert. denied, 496 U.S. 936, 110 S.Ct. 3215, 110 L.Ed.2d 662 (1990). However, if it has not expired before the government acquires the claim, then the government will enjoy the full length of the federal statue of limitations.
In United States v. Summerlin, 310 U.S. 414, 60 S.Ct. 1019, 84 L.Ed. 1283 (1940), the Court held “that the United States is not bound by state statutes of limitations in enforcing its rights.” Therefore, the relevant federal statue of limitations for contract actions is contained in 28 U.S.C. § 2415(a) and is six (6) years. Therefore, the SBA, as a federal agency has six (6) years to file a lawsuit to collect, but is not barred by any limitations period in an action to foreclose on real property. In this case, 28 U.S.C. § 2415(a) is silent on foreclosure actions. The Supreme Court has instructed that, as a sovereign, the United States is subject to a limitations period only when Congress has expressly created one. Guaranty Trust Co. v. United States, 304 U.S. 126, 133, 58 S.Ct. 785, 789, 82 L.Ed. 1224 (1938) (citing United States v. Thompson, 98 U.S. 486, 488-89, 25 L.Ed. 194 (1878)). In the absence of such a limitation none exists. In Farmers Home Administration v. Mudhead, 42 F.3d 964 (5th Cir. 1995), the court also noted that there is “absent a specific federal limitation” and commented that “28 U.S.C. § 2415(c) does not apply to actions to foreclose mortgages.” Id. at 966 & n.5.
Therefore, when reviewing a foreclosure action in connection with a defaulted SBA loan, borrowers should not be surprised to find themselves embroiled in a foreclosure action many years into the future and well beyond the state state of limitations for such actions.