"Arm's Length" Buyer in a Workout... What's That?

This is a very important concept in a workout as so many borrowers in default believe they can protect their assets and business by selling to their wife, son or daughter, brother or sister, mother or father... all "insiders" or buyers who, by definition, are not "arm's length" buyers.

It is generally understood and accepted that people with close family ties will lie for each other and thus any sale to such an insider is deemed fraudulent on its face without the need to demonstrate or prove any fraudulent activity taking place. It is simply assumed. These transactions are easily pierced and undone, returning everything to the way it was. We have had banks object to managers of a business wanting to buy out existing owners, stretching the "insider" concept even further than it was intended.

Additionally, it is entirely possible (and even likely) that money may be borrowed from your family even before the bank lends. Thus, the family loan is on file in front of the bank's, assuring your family priority in the case of default, which can be very helpful to the borrower for many reasons.

The point being, if your parents' loan for your new start-up is handled impeccably from the start, in default that will serve valid purpose as the terms are enforceable and thus it must be respected and dealt with. If not defined properly, it will be ignored, and not only will a loss occur, but you will have lost the protective benefit of such a filing.

There have been situations, however, when we wanted to use an insider for a variety of reasons, all legitimate but still a violation of insider sales. We disclosed the buyer's relationship and supported our sale with an appraisal of which the value determined would be paid. We have convinced the bank or the SBA to accept these sales despite such irregularities if presented effectively, with integrity and documented support.