SBA Offer in Compromise vs. Bankruptcy

Preliminary Bankruptcy Analysis

An SBA Offer in Compromise or a compromise offer to the Treasury Department (DOT) is an out-of-court settlement request and is an alternative to filing for bankruptcy.

Depending on an SBA debtor’s income, expenses, assets and liabilities, the SBA debtor may or may not qualify for a Chapter 7 bankruptcy, a Chapter 13 bankruptcy or even a Chapter 11 bankruptcy.  It all depends on a number of several conditions and factors.

In general, to file a Chapter 13 bankruptcy, a debtor’s unsecured debts must exceed at least $383,175 and/or the secured debts must exceed at least $1,149,525

Chapter 13 bankruptcy requires debtors to repay creditors via a repayment plan that can last for up to 5 years.  Such a repayment plan would include SBA loan debt. Moreover, debtors should be aware that over 67% of all Chapter 13 cases generally DO NOT result in a discharge.

For Chapter 7 – It is important to discover if your median annual gross income for your household in your zip code meets the requisite thresholds.  If you are interested in a Chapter 7 bankruptcy, go to https://www.legalconsumer.com/bankruptcy/means-test/ to find out if you qualify.

Note that even if you are under the median gross income for your area, any equity you may have in any of your reachable assets may be at risk to be seized by the bankruptcy trustee and sold to repay your debts.  You may be entitled to certain exemptions in the equity you have in your assets, but if any verifiable equity exceeds the statutory exemption amounts, your assets may be vulnerable to pay creditors.

To file bankruptcy, a debtor may have to do a great deal of expensive pre-filing asset protection transactions (which could also expose the debtor to certain fraudulent conveyance issues, a DOJ investigation and possibly a non-dischargeability finding by a bankruptcy judge).  This would be an expensive Chapter 7 and one where there appears to a great deal of risk that could materialize with an SBA debtor possibly losing some of his or her assets.

In addition, filing for a Chapter 7 can be very overwhelming.  

Chapter 11 – Individuals can file under a Chapter 11 reorganization.  However, Chapter 11 cases can be expensive and it is estimated that only 10% to 15% of Chapter 11 cases result in successful reorganizations. Most cases are dismissed or converted to Chapter 7 liquidations.

Even for a “simple Chapter 11” you can expect a qualified attorney to be paid a $25,000 retainer fee.  Chapter 11 cases, unlike Chapter 7 or Chapter 13 cases, are often not done on a flat fee basis but, instead, on an hourly basis and you can expect that retainer to be used up fairly quickly.  If the case gets dismissed or converted, you are in the same situation you are in now and at risk to lose assets, plus you will be out a significant amount of money for bankruptcy attorney fees and costs.

In conclusion, although Chapter 7 or Chapter 11 bankruptcies are potential options, there appears to be a great deal of risk and those options do not seem to be any less expensive than dealing directly with the SBA debt as part of a bankruptcy alternative settlement.

What Are The Disadvantages Of Filing A Chapter 7 Bankruptcy?

o  Taking bankruptcy can weaken your ability to get credit, especially at a low interest rate. Also, your bankruptcy may haunt you when a prospective employer looks up your credit report as part of a reference check.

o  The trustee takes over complete control of your debts and finances from the day you file until the judge discharges your case.  You can’t spend anything without the trustee’s approval.

o  For Sole Proprietors and Partnerships: The costs, hassles and surrendering of your property could cause you to close your business.

o  You may lose a large amount of wealth if you have a large amount of nonexempt personal property or a large amount of equity in secured assets such as your house and cars.  There is a chance you could lose any rental properties to the trustee.

What Are The Disadvantages Of Filing A Chapter 13 Bankruptcy?

o  You may pay much more to settle your bankruptcy under Chapter 13 than Chapter 7.

o  You may have more hassle and headaches.  For three or five years, you have a trustee running your financial life.

o  If you miss payments under the plan, you may be at risk of having your bankruptcy dismissed and you are back at square one.  Over 67% of Chapter 13 filings end up dismissed or converted to Chapter 7.

o  You can’t take on any more debt while you’re in Chapter 13.  This can stop business growth when you are a sole proprietor and limit your lifestyle options.

What Are The Disadvantages Of Filing A Chapter 11 Bankruptcy?

o The process of obtaining approval of your reorganization plan is long and expensive.

o Chapter 11 cases are subject to much more assertive and aggressive creditor action, including adversary actions (lawsuits filed against you within the context of the bankruptcy proceeding).  Active creditors make Chapter 11 cases more expensive and more drawn out for long periods of time, thereby increasing your attorney’s fees.

o As a general rule of thumb, Chapter 11 cases can cost upwards of $50,000 at a minimum.

Are There Any Hidden Costs To Filing Bankruptcy?

o Filing for bankruptcy also has a “hidden” cost.  Operating in the business world is complicated when the borrower files for bankruptcy, and these complications can cost real money over the 10 years that a bankruptcy is reported on a credit report.

It has been estimated that the “hidden” cost of filing bankruptcy is between $75,000 – $150,000.  Stated another way, if an SBA debtor can afford an SBA Offer in Compromise or DOT settlement for less, it is probably a good idea to try and obtain an SBA Offer in Compromise or DOT compromise.  However, if the SBA Offer in Compromise or DOT compromise settlement cost is higher than the “hidden” bankruptcy cost, then the SBA debtor should probably seek protection through a bankruptcy.