This is an article I wrote about my friends who got hosed by the Bank of Oklahoma. I pulled out their names, but if you want to reach them, contact me and I'll put you in touch.
LR and her husband DM lived the American dream with four furniture stores and two other commercial investment properties in Enid, Okla. Annual sales were $5 million and they had $1.3 million in inventory.
So, why would the bank foreclose on their lines of credit when they were experiencing a giant business growth and expanding? It all came down to terms LR and DM never knew existed: technical default and cross collateralization. That ignorance cost LR and DM their business; eventually forcing them into bankruptcy.
In fall 2006, LR and DM had several lines of credit and four buildings all financed at the same bank. The grand total for all the loans was $1.2 million.
After 10 years in business, they were growing their furniture empire. They had the same banker for the life of their business and were friendly with her, too.
“Never forget that even if you’re friends with your banker, their loyalty is to the bank,” LR said.
By May 2006, their credit line was renewed and they had bought two buildings. In August, their credit line was renewed and increased. It was September before LR realized something was terribly wrong.
When the couple decided to buy a $500,000 building in May, LR told her banker that they could only put down 5 percent. But, at closing, her banker surprised her with the announcement that they needed 15 percent down.
“We told her that we couldn’t do it. We needed an additional $25,000 and we only had $50,000. She said she would cover us and not to worry about it,” LR said. So, they didn’t give it another thought.
What the banker did was take the money out of the business account, causing it to be overdrawn. It wasn’t until September that LR noticed non-sufficient funds fees stacking up. By the time she realized what was happening, the business had $13,000 in NSF fees.
“By November, everything started to go downhill,” LR said. “We called our banker and reminded her she said she’d cover any associated costs with the closing. She said she’d have to go to her bosses for that amount.”
LR said her accountant figured that, by September, her business had paid the bank $52,000 in interest alone, so she assumed the bank could refund them the $13,000 in fees and still make money.
“The day after I called her, we heard from the bank’s special assets team. By February, there was a lawsuit,” LR said. “They said they wanted us out of their bank, but we thought that meant they were going to shop our loan out to someone else. We didn’t know they were going to call our note and that they could call in everything in addition to that single line of credit on a technical default. They didn’t need a reason.”
LR said she learned a costly lesson from the experience about cross collateralization and technical default.
Cross collateralization is when collateral
for one loan
is also serving as collateral for other loans. In the real estate
market, it can occur when a person already owns a house, and wants to buy another one. Technical default happens when an affirmative or a negative covenant is violated. Affirmative covenants are clauses in debt contracts that require firms to maintain certain levels of capital or financial ratios
. The most commonly violated restrictions in affirmative covenants are tangible net worth, working capital/short term liquidity, and debt service coverage.
“You really need to spread the wealth to different banks. If some situation arises, it is easier to go to a banker with an established relationship and we’d have multiple accounts in multiple banks,” LR said. “The trap that we fell into, and many small businesses fall into it, is that it is easy to go to one person and have them hand you a check for $60,000 and say go buy a building.”
She said it is harder to go to a bank with profit and loss records for the past three years and wait 60 to 90 days for the process to complete. But, she would recommend doing that to other business owners.
“It is hard for a small business with a collateral base like a furniture store to split up their accounts between inventory and accounts receivable, but they could have their equipment or building debt split among other banks,” acknowledged a commercial lender with a Fort Worth, Texas,-based bank. “It is hard to have multiple lines of credit on same the same collateral pool, but it is good to have strong relationships with several bankers. It takes the pressure off of me to say yes to every request.”
Keeping options open with other lending institutions even when the relationship is satisfactory is a good idea, he added. Talking monthly or quarterly with your banker is recommended, so they are up to date and there are no surprises, he added.
Plus, the banker agreed that business owners should ask lots of questions and shop around to other banks.
“In the end, it may be the smartest thing you do,” LR said. “We put our faith in the bank. All of our notes were current. Our employees were happy, our vendors were happy and our customers were happy.”
After Chapter 11 bankruptcy, LR and DM have relied on loans from family and friends and now have one small store that they are doing a lease-purchase directly from a friend. LR's mother is the president of a limited liability corporation. They work for her.
“We’re no longer credit worthy as individuals. The day they kicked us out of our business, they didn’t pay us our paychecks. If the bank doesn’t get all their money they can come after us personally, too,” LR said. “We literally used up every bit of our savings on the building and we only took paychecks to cover our bills.”
LR said that is probably the biggest mistake they made as small business owners: putting everything they own back into the business.
“Even some banking attorneys have told me that you need to have some stash of money somewhere that is safe and legal. It sounds really simple, but next time we will have more money for ourselves and some of it will be put in that figurative jar in the back yard.”
Additional good info:
Santa Barbara, Calif., law firm Cappello & Noël LLP Trial Lawyers created “10 Rules to Remember When Borrowing Money from a Bank” that provides good information for consumers and small business owners, alike.
1. Don’t rely on what your banker tells you; get it in writing.
2. If you get a loan commitment, be sure it is in writing and includes all the terms of the loan.
3. Get all important statements by your loan officer confirmed in writing.
4. Read every document before signing; if you have any questions, ask.
5. If you have any questions about your loan documents or your rights under them, contact a lawyer.
6. Never give a lender a security interest in something you can’t live without.
7. If your banker tells you something that sounds unusual, check it out.
8. Be aware of what you’re giving up if you sign a jury trial waiver, an arbitration clause or a release.
9. If you suspect your lender has done something improper, do something about it doctrine known as "waiver of the fraud" is being used by lenders to prevent borrowers from prosecuting their claims.
10. Don’t ever forget that your banker’s allegiance is to the bank and not to you.