How much should I expect to settle with my OKI?
The answer to this is complicated. It is determined by many factors, which I will explain below.
Background: When a borrower holding a bank loan, guaranteed by the SBA, defaults, the borrower has the option of seeking protection by filing Chapter 7 Bankruptcy (assuming the borrower is eligible…more on that in another post). However, the SBA (and the bank, which acts as the SBA’s service agent) has the option to allow borrowers who fail to make an Offer In Compromise (OIC) in lieu of a Chapter 7 bankruptcy filing. obligated to accept the OKI, 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 often confusing, and feels like they are using black magic to find out, and relies heavily on the individual reviewing the file. However, there are guidelines, such as those listed in the SBA SOPs. According to the SBA SOP on OKI,
“The compromise amount must have a reasonable relationship to the amount recoverable within a reasonable amount of time through a forced collection process and must be sufficient to protect the integrity of the SBA loan program.”
So what does this mean? In simple terms, acceptable OKI is determined by eight (8) general criteria:
1. Size shortage:
The magnitude of the shortfall is an obvious factor in determining the “settlement”. However, while there is a belief that the SBA “appears” to be gaining a 20% recovery, there is actually no magic percentage that the SBA will receive. That’s because whether the borrower’s shortfall is $150,000 or $1,500,000 only meaningful in the context of another criterion – namely, what can the borrower actually pay? What are the borrower alternatives?
2. The liquidation value of the borrower’s assets if the borrower seeks protection in Chapter 7 Bankruptcy (BK)
This is definitely an OKI alternative for borrowers. This is a calculation that must be done, and very meaningful to convey to the bank and/or SBA. If the borrower has limited exposure in the BK application, it will have an impact on how the SBA views OKI… but the borrower should remember, that even if they have NO obligation in the BK application, and their personal guarantee will be fully waived, the SBA may STILL require an OKI settlement amount significant and substantial, based on the Net Worth of the borrower and their ability to repay.
3. Borrower’s net worth if they do NOT seek BK protection.
Many defaulting borrowers assume that “excluded” assets do not factor into the SBA’s thinking in terms of the OKI. This is not true. Even though IRAs and 401Ks are “excluded” from consideration in BK filings, the SBA will still consider these assets when examining OKI. Why? Because OKI is a PRIVATE RIGHT… and in many cases, SBA officers feel that borrowers should include their assets – even excluded assets – to demonstrate OKI’s good faith.
4. Recovery if SBA seeks pay cuts for five (5) years
The SBA will also consider the earning power of the underwriters. We recently spoke with a high-powered attorney who failed to pay ~$600,000. The SBA demands $300,000 from him, although if he does apply for a BK, the exposure is less than $30,000. Why? Because he makes $250,000+ per year. They thought that if they garnished his salary (which they could have done had he not applied for a BK), they would have raised $300,000 over five years. In this case, the SBA guessed wrong – the borrower applied for a BK.
5. The Borrower’s “Wish” to avoid Bankruptcy
This is an obscure calculation, but I advise my clients that applying for a BK has a “hidden” cost. Operating in the business world becomes complicated when a borrower applies for a BK, and this complication can cost a lot of money over 10 years after the BK is reported on a credit report. I estimate it would cost between $75,000 – $125,000. In other words, if the borrower is able to afford the OKI settlement at a lower price, it is a good idea to settle it. However, if the settlement fee is higher than that, as in the case of the lawyer I mentioned above, then the borrower must seek protection through BK.
6. Offer Structure
Many borrowers ask us whether they can draw up a Payment Plan for their OKI or not. The simple answer is yes, but… be prepared that the amount the SBA will demand under the terms of the payment plan is usually higher than if the borrower could make one offer at a time. The reason is simple: many borrowers on payment plans default on those plans. The SBA understands this, and therefore demands a higher settlement amount to reflect the increased “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 the borrower is 65 years old, the hidden costs of BK are negligible because net credit report scores mean nothing to most people nearing retirement. Likewise, significant health issues affecting the borrower will affect the SBA’s consideration of the OKI. Other factors that may affect SBA are sick children, divorce, or sudden job loss.
8. Administration fee
This sounds trite, but the SBA and the banks involved are both large and relatively inefficient bureaucratic entities. As such, they have operational costs, and for them to turn the wheel of progress and actually process the OKI, the offer should be enough to keep them interested. For borrowers with NO exposure in BK, NO other collateral, and NO liens on private property, this figure is relatively modest…perhaps as low as $10,000 – $15,000. If there is a lien on private property, the bank must now expend resources to remove this lien (legal fees) which could increase the cost by another $10,000 or more.
In the end, trying to estimate how much it will cost to settle a failed borrower’s OKI is an exercise based on several factors and criteria. And there is no single answer – every situation is different and unique.
