Once a loan is classified into liquidation status, a lender will likely incur expenses relative to liquidation and collection. In many instances, lenders will retain legal counsel to assist the lender with enforcing its rights under the loan documents, including repossessing and liquidating collateral with recoverable value.

When the defaulted loan is a Small Business Administration (“SBA”) guaranteed loan, the lender may not need shoulder 100% of its legal expenses. Pursuant to SBA Standard Operating Procedure (“SOP”) 50 57 2, attorneys’ fees and costs may be deemed Recoverable Expenses, and a lender may seek recoupment of a portion of its legal expenses from SBA.

That said, SBA does not provide a lender with blanket reimbursement for any and all attorneys’ fees and costs incurred by a lender in connection with liquidation and collection of the SBA loan. Attorneys’ fees and costs that a lender seeks to recoup as a Recoverable Expenses must be approved by SBA. In addition, there are two overarching principles that guide whether SBA will deem attorneys’ fees and costs as Recoverable Expenses.

First, the SBA loan guaranty will only cover attorneys’ fees and costs incurred in the collection of an SBA loan provided they are necessary, reasonable, and customary for the locality where the litigation/liquidation takes place. Second, even when the attorneys’ fees and costs are necessary, reasonable, and customary, in certain instances, SBA will only reimburse legal fees to the extent SBA has approved a Litigation Plan. Therefore, lenders must identify what legal fees SBA considers necessary, reasonable and customary, and assess when a Litigation Plan or Amended Litigation Plan must be submitted to SBA for approval.

Legal Fees Must Be Necessary, Reasonable, and Customary

While the necessity and reasonableness of legal fees may vary based on the jurisdiction, the collateral securing the loan, and the overall likelihood of recovery, there are certain attorneys’ fees that a lender may incur which SBA has deemed to be Non-Reimbursable Expenses.

In particular, SBA will not reimburse a lender for fees incurred related to outside counsel assisting with tasks SBA deems to be routine loan servicing or liquidation duties, such as preparing a demand letter, Liquidation Plan, Purchase Package, or a performing a Protective Bid analysis. Additionally, legal fees charged for intra-law firm communications, overhead for setting up a file, calendaring, secretarial work, and billing by more than one person for the same activity will not be reimbursed by SBA.

Importantly, SBA presumes that non-itemized bills for attorneys’ fees and costs as unreasonable. Therefore, it is important for lenders to ensure their retained legal counsel provides itemized invoices that comply with SBA requirements.

Additionally, when attorneys’ fees and costs exceed the recovery obtained by a lender in a lawsuit, which was undertaken without an SBA approved Litigation Plan, those attorneys’ fees and costs are presumed to be unreasonable by SBA, even when the legal fees may be under the $10,000 threshold to require a Litigation Plan. Put simply, if the collection action is not cost-effective, SBA will not consider the legal fees to be Recoverable Expenses. This presumption can place a lender in a difficult position, as a lender may reasonably anticipate a recovery that unfortunately never comes to fruition, despite the lender’s best efforts. In order to avoid a potential denial of reimbursement of legal expenses, before commencing liquidation and/or litigation, a lender needs to do its homework. A lender should first assess the anticipated recovery from the collateral, calculating the net Recoverable Value of any collateral securing the loan and the likelihood of collection from any Obligors, which calculations should include the anticipated legal fees and costs associated with the chosen action. Lenders need to balance the anticipated recovery with the anticipated expenses prior to commencing litigation, making sure to document any mitigating circumstances should the ultimate recovery not align with the anticipated recovery.

Know When to Submit a Litigation Plan or an Amended Litigation Plan

Even when legal expenses are necessary, reasonable, and customary, SBA will not consider the attorneys’ fees and costs as Recoverable Expenses if the fees were incurred through Non-Routine Litigation and there is not an SBA approved Litigation Plan. Under SOP 50 57 2, there are five broad categories of Non-Routine Litigation:

  1. Any litigation when factual or legal issues are in dispute;
  2. Any litigation involving a loan where the lender has an actual or potential conflict of interest with SBA;
  3. Any litigation involving receivership proceedings;
  4. Any litigation where the lender has made a separate, non-SBA loan to the same borrower; and
  5. Any litigation when legal fees are in excess of $10,000.00.

If the litigation falls under any of these five categories, a lender needs an SBA approved Litigation Plan in order for the legal fees to be classified as Recoverable Expenses, absent emergency situations. In addition, if Routine Litigation transfers to Non-Routine Litigation, then a Litigation Plan needs to be submitted.

However, receiving an SBA approved Litigation Plan does not conclude a lender’s responsibility to monitor legal expenses. An SBA approved Litigation Plan sets forth a specific budget for legal fees and costs. Therefore, a lender should submit an Amended Litigation Plan if the anticipated or actual legal fees increase by more than 15% in excess of the budget set forth in the approved Litigation Plan to avoid a potential denial of reimbursement. Unless there are emergency circumstances, a lender should submit the Litigation Plan or Amended Litigation Plan to SBA before exceeding $10,000.00, or 15% in excess of the budget set forth in the approved Litigation Plan.

Communicate with Legal Counsel Throughout Litigation

Because lenders will need a Litigation Plan in place if legal fees exceed $10,000, lenders should request an anticipated budget from their attorneys at the outset of commencing litigation and monitor the expenses throughout the course of the litigation. A lender and its legal counsel will want to keep an open line of communication as to legal fees, in order to allow the lender to submit a timely Litigation Plan for SBA approval before attorneys’ fees surpass $10,000.00, or seek amendment of an approved Litigation Plan, should the fees increase to 15% in excess of the budget set forth in the approved Litigation Plan. In short, as expenses accumulate, a prudent SBA lender should evaluate whether it needs to submit a Litigation Plan for SBA review and approval and continue to monitor its legal expenses to assess if/when an Amended Litigation Plan is appropriate. Likewise, lenders will want to be apprised of the status of litigation, including whether there are factual or legal issues in dispute, so a timely Litigation Plan can be submitted should litigation change from uncontested to contested.

In short, absent emergencies, if a lender seeks recoupment for attorneys’ fees and costs in excess of $10,000 without an approved Litigation Plan or seeks recoupment for attorneys’ fees and costs in excess of 15% of the approved Litigation Plan, the request will likely be denied. Therefore, working with an experienced law firm which is versed in SBA’s requirements can allow a lender to have a firm grasp on expenses incurred to date and ensure that a lender submits timely and well-supported requests for reimbursement of Recoverable Expenses.