SOP 50 51 2C (Excerpt) — Default or Business Failure That Occurs More Than 18 Months After Final Disbursement

Summary

Part of SBA Standard Operating Procedure 50 51 2C, effective September 6, 2005, on when SBA may seek a repair or deny part or all of its guaranty. For a default more than 18 months after final disbursement, staff weigh time in business, the loan's size against the assets bought and depreciation, and the SOP calls for judgment. Paragraph 24 requires lenders to verify the borrower's equity injection before disbursing; for a cash injection above 1/3 of the loan amount or $200,000, whichever is less, the lender must also verify its source. A promissory note, gift letter or financial statement alone is generally not sufficient, and a shareholder loan used as an injection needs a full standby agreement or evidence that an entity other than the borrower made the loan payments. After an early default with an undocumented significant cash injection, a full denial of liability may be appropriate.

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SOP 50 51 2C

or nearly new.

(ii) Default or business failure that occurs more than 18 months after
final disbursement

Under these circumstances, financial staff should consider a number of
factors including length of time the borrower was in business; the relative
size of the SBA loan compared to the business assets to be purchased; the
type of assets purchased; normal depreciation or obsolescence of the
assets; and whether there has been replacement of the assets with leased
items, or by assets financed with purchase money security interest
financing. Repair or full/partial denial may or may not be appropriate
depending on the circumstances. An exercise of judgment is required.

23. Change of Ownership

In cases where whole businesses are purchased, asset values may not reflect fair market
value and may bring little recovery at liquidation, even a short time after disbursement.
Each case requires the exercise of judgment based on the condition of the assets when
purchased and normal depreciation in the business operation prior to and subsequent to
the change in ownership.

24. Borrower’s Injection

Lenders are required to verify injections prior to disbursing loan proceeds and must
maintain evidence of such verification in their loan files. Lenders are expected to use
reasonable and prudent efforts to verify that equity is injected and used as intended, and
failure to do so may warrant a repair or partial/full denial. Lenders must submit with
each purchase request on a loan for which the loan authorization required an equity
injection, documentation to show that they verified the equity injection. Generally, SBA
staff will review this documentation only when the loan has experienced an early default
or early loan problems, although SBA may review this documentation for other loans as
well if circumstances warrant. SBA staff will consider the following in determining
whether to seek a repair or recommend full/partial denial:

a. Cash Injection

Verifying a cash injection requires documentation such as a copy of a check along
with evidence that the check was processed (e.g., at least one bank account
statement dated before, but close to, disbursement showing that the funds were
available and deposited into the borrower’s account), or a copy of an escrow
settlement accompanied by a bank account statement showing the injection into
the business prior to disbursement. A promissory note, “gift letter” or financial
statement alone is generally not sufficient evidence of cash injection.

For any cash injection that is greater than 1/3 of the loan amount or $200,000,
whichever is less, the lender must also verify and document the source of the cash
injection. If the cash injection is less than both of these amounts, the lender is

EFFECTIVE DATE: September 6, 2005 13-14
SOP 50 51 2C

required to verify and document only the existence of the cash injection, but not
also its source.

If a shareholder loan is used as an equity injection, the lender must produce a full
standby agreement, or evidence to show that loan payments were made by an
entity other than the borrower. The lender must also present credible evidence to
demonstrate that the borrower did not use 7(a) loan proceeds to fund the required
injection, such as a bank statement showing that the money was available prior to
the disbursement of the loan. The sufficiency of evidence from a lender to
demonstrate verification of a cash injection depends upon the size of the injection
and length of time that a borrower was in business, as discussed below.

b. Asset Injection

Asset injections may be more difficult to verify than cash injections. Evidence is
often located in the lender’s application for guaranty, in the borrower’s financial
statements, or in the SBA loan processor’s write-up, as applicable. SOP 50 10 4
requires lenders to carefully determine the value of non-cash assets injected into
the business. See Subpart A, Chapter 4, Paragraph 1(f)(4).

c. Length of Time in Business

If there is an early default or early loan problem and a significant cash injection
(see discussion below in subparagraph (d)) is not properly documented, a direct
link between business failure and the lack of injection should be assumed, and a
full denial of liability may be appropriate. If the loan experienced early default or
early loan problems, a lender's failure to verify a significant cash injection may be
related to potential loss on the loan. If default occurs after 18 months from final
disbursement, an exercise of judgment is required based upon an analysis of the
cause of business failure and the length of time the business remained open. For
example, if the business was in operation for several years after disbursement, the
lender may be able to demonstrate that the lack of borrower’s injection did not
play a significant role in the failure. In this situation, a repair or partial denial in
the amount of the unverified cash injection would generally not be appropriate.

d. Size of Injection

The amount of the required injection and the size of the loan should be compared.
A relatively large injection is generally more instrumental to the business’ success
than a small injection. Lack of a small injection usually is not a significant factor
in the failure of the business unless this failure is combined with a number of
other lender deficiencies.

e. Partial Verification of Injection

EFFECTIVE DATE: September 6, 2005 13-15

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