B-228857, Feb 22, 1988, 67 Comp.Gen. 271

B-228857, Feb 22, 1988, 67 Comp.Gen. 271

APPROPRIATIONS/FINANCIAL MANAGEMENT - Federal Assistance - Bonds - Refinancing - Advance Payments - Minority Businesses DIGEST: Unless it receives adequate legal consideration, the Small Business Administration (SBA) has no authority to agree to a refinancing proposal whereby Minority Enterprise Small Business Investment Companies (MESBICs) would prepay high-interest rate debentures held by SBA for the purpose of refinancing them with new debentures that SBA would agree to purchase at the current lower interest rates. An alternative proposal under which MESBICs would pay a so-called prepayment penalty in the form of a non-interest-bearing note payable over a 10-year period as consideration for SBA's reduction of the interest rate on the existing debentures, is not acceptable either because the purported consideration is inadequate.

The Honorable Dale L. Bumpers:

This opinion is in response to your joint letter with The Honorable Lowell Weicker, Jr., Ranking Minority Member, dated August 17, 1987, requesting our Office to review a ruling of the General Counsel of the Small Business Administration (SBA) that SBA could not allow Minority Enterprise Small Business Investment Companies (MESBICs) to prepay high interest rate debentures held by the SBA for the purpose of refinancing them with new debentures that SBA would agree to purchase at the current lower interest rates. For the reasons set forth hereafter and subject to the exception discussed herein, we agree with the General Counsel's view that unless SBA receives adequate legal consideration, SBA has no authority to agree to the proposed refinancing, which would, in effect, require the government to waive its contractual right to interest at the higher rate stated in the original debentures. Moreover, we do not think that an alternative proposal made by the National Association of Investment Companies(NAIC), under which MESBICs would pay a so-called "prepayment penalty" to SBA as consideration for SBA's agreement to reduce the interest rate on these debentures for the remainder of their terms, would remedy the legal deficiencies of the original proposal.

BACKGROUND

Under section 303(c) of the Small Business Investment Act(Act), 15 U.S.C. Sec. 683(c), SBA is authorized to provide financial assistance to MESBICs, (as defined by section 301(d) of the Act, 15 U.S.C. 681(d)), by purchasing debentures from them. The interest rate on debentures issued by MESBICs is established in accordance with section 317 of the Act, 15 U.S.C. Sec. 687i, which grants MESBICs an interest subsidy of 3 percent for the first five years of the term of the debenture. /2/

Because current interest rates are significantly lower than they were five years ago and the 5-year subsidy period on MESBIC debentures that SBA purchased in those years has expired or is about to expire, many MESBICs wish to refinance these debentures at today's lower interest rates. Accordingly, in 1986 NAIC asked SBA whether MESBICs could refinance their indebtedness to SBA by prepaying their existing high interest rate debentures and then selling new debentures to SBA at the much lower interest rate currently in effect.

On March 28, 1986, SBA's General Counsel issued a memorandum that while recognizing the right of MESBICs "to prepay their indebtedness to SBA without penalty", held that SBA had no authority to agree to the refinancing aspect of the proposal. The General Counsel's memorandum reads as follows in that respect:

"*** But the right to prepay without penalty does not carry with it the right to have the proposed indebtedness refinanced on terms that amount to a gift, which is precisely the result of a refinancing at a lower rate. Except in a compromise case due to a debtor's inability to make payment in accordance with the terms of the debt instrument, SBA has no authority to waive its contractual rights in consideration of the debtor's payment of (or undertaking to pay) a lesser sum. To the extent that SBA discharges a debtor from the obligation to pay interest at the rate of X percent, in consideration of the debtor's promise to pay interest at the rate of X minus Y percent, it is making a gift equal to the difference between the two rates; and such an action exceeds SBA's legal authority."

"*** prepayment/refinancing is precluded only when SBA, as creditor, receives no consideration other than the promise to pay interest at a lower rate."

After being advised of SBA's position rejecting the original debenture refinancing proposal, NAIC made an alternate proposal to SBA. Under this proposal, MESBICs seeking refinancing would tender to SBA a non-interest- bearing promissory note, payable in annual installments over a 10-year period, in a face amount equal to the prepayment penalty that would be required under an SBA formula for debenture prepayment by SBIC that do not qualify as MESBICs under section 301(d) of the Act. In return, SBA would agree to lower the interest rate on the debentures for the remainder of their terms to the rate currently paid by (non-MESBIC) SBICs.

In a memorandum dated May 13, 1987, SBA's Chief Counsel for Investment, Office of Finance and Legislation, concluded that the NAIC proposal was unacceptable because it "ignores the substantial difference" between the present value of a sum of money (the prepayment penalty) and the discounted value of the same sum when it is paid in annual installments over a 10-year period, without interest. You have asked us to review SBA's position that neither the original nor alternative proposal are legally acceptable.

ANALYSIS

It has long been recognized that unless specifically authorized by statute, the officers and agents of the government have no authority to waive contractual rights which have accrued to the United States or to modify existing contracts to the detriment of the United States without adequate legal consideration or a compensating benefit. 62 Comp.Gen. 489, 490 (1983); B-207165, May 3, 1982, 45 Comp.Gen. 224, 227 (1965); Union National Bank v. Weaver , 604 F.2d 543, 545 (7th Cir. 1979).

This principle is applicable to SBA's contractual right to interest on the existing debenture in accordance with the interest rate set forth therein and, in the absence of specific statutory authority, would prohibit SBA from agreeing to lower the interest rate on these debentures without adequate legal consideration. The original proposal SBA was asked to consider, in which MESBICs would refinance their indebtedness to SBA by substituting new lower rate debentures for the existing higher rate debentures, does not provide for the payment of any additional consideration to SBA.

Thus, the first issue for us to consider is whether SBA has specific statutory authority that would allow it to relinquish its contractual right to receive interest at the higher interest rate provided for in the existing debentures without additional consideration. Our review of SBA's enabling legislation reveals one provision that is relevant in this respect. Under section 5(b)(7) of the Small Business Act, as amended, 15 U.S.C. Sec. 634(b)(7), which is made applicable to the functions and activities authorized by the Small Business Investment Act in section 308(f) thereof, 15 U.S.C. Sec. 687(f), the Administrator of SBA has authority to:

"*** take any and all actions *** when he determines such actions are necessary or desirable in making, servicing, compromising, modifying, liquidating, or otherwise dealing with or realizing on loans ." (Emphasis added.)

See , generally, 44 Comp.Gen. 549 (1965); and 58 Comp.Gen. 138 (1978).

While this provision undeniably gives the Administrator of SBA broad authority to take various actions in dealing with loans, including authority to modify the terms of a loan, we have held that the Administrator's authority to deal with loans under this section "is not unlimited." See, B-181432, August 11, 1978, and cases cited therein. Moreover, in several cases, we have implicitly rejected the view that this provision gives SBA the authority to modify a loan agreement to the detriment of the United States without consideration. For example, in B-181432, March 13, 1975, we held that SBA could not agree to accept guarantee fees from banks after a supposedly guaranteed loan went into default, thereby committing itself to honor the guarantee, since such action would modify to the government's detriment, a provision of the loan guarantee agreement that required payment of the guarantee fee before a loan was covered by SBA's guarantee. /3/ See also, B-181432, October 20, 1978 and B-181432, February 19, 1976. Thus, it is our view that the Administrator's authority under 15 U.S.C. Sec. 634(b)(7) to modify the terms of a loan should not be interpreted as allowing SBA to waive the government's right to receive interest at the rate stated in the existing debentures without adequate legal consideration.

In reaching this conclusion, which is consistent with SBA's position in this case, we are not questioning the view of SBA's General Counsel that MESBICs "have a right to prepay their indebtedness to SBA without penalty." However, prepayment is not legally acceptable if it is part of an arrangement whereby, without additional legal consideration, SBA agrees to purchase new debentures bearing a lower rate of interest. Allowing refinancing in such circumstances for the sole purpose of enabling a MESBIC to reduce the interest it must pay to SBA is tantamount to providing the MESBIC with a loan bearing a floating rate of interest, albeit at a rate that would only decrease. Obviously, a MESBIC would only take advantage of this refinancing option when interest rates had declined. However, if interest rates increased, SBA would be "locked in" at the original interest rate for the remainder of the term of the debenture. Since the statute authorizing the program envisions debentures bearing a fixed interest rate, with a 3 percent subsidy for the first 5 years, allowing MESBICs to refinance whenever interest rates went down would provide MESBICs, in our view, with a significant additional benefit and concession not contemplated by the enabling legislation. See 15 U.S.C. Sec. 683(b) and 687i. For this reason, SBA has adopted the policy of requiring any MESBIC that prepays a debenture prior to its maturity to wait until after the original maturity date on that debenture before SBA will process its application for new financing. In our view, that policy appears to be reasonable and consistent with the underlying legislation.

Our conclusion that SBA does not have authority to implement the proposal is subject to one exception. As stated by SBA's General Counsel, an exception to the refinancing prohibition exists in a "compromise case." We agree that based on the express authority the Administrator of SBA has under 15 U.S.C. Sec. 634(b)(7) to "compromise" loans, SBA can agree to reduce the interest rate on existing debentures based on the "debtor's inability to make payment in accordance with the terms of the debt instrument." As we recognized in 62 Comp.Gen. 489, at 492 (1983), a compromise can be justified under this type of statutory authority when there is "some genuine doubt as to the collectability of the entire amount of an undisputed debt." However, the desire of MESBICs to reduce the amount of money they must pay to service their debt, albeit understandable, does not constitute genuine doubt as to the debt's collectability that would justify such a compromise.

NAIC's alternative proposal raises a different issue. Having determined that SBA has no specific statutory authority to agree to waive the government's rights to rights to interest at the rate provided for in the existing debentures without adequate legal consideration, we must decide whether the alternative proposal would provide SBA with the necessary consideration missing from the original proposal. In return for SBA's agreement to reduce the interest rate on the existing debentures for the remainder of their terms, NAIC has proposed MESBICs give SBA non-interest- bearing notes, payable over a 10 year period, in face amounts equal to the prepayment penalty that SBA would require from SBICs that do not qualify as MESBICs. In our view, such a "prepayment penalty" would not constitute adequate legal consideration to support SBA's modification of the existing debentures.

As explained by SBA's Chief Counsel for Investment in his memorandum of May 13, 1987, the purpose of a prepayment penalty is to enable the creditor to realize the same return on the prepaid principal that it would have received on the original investment. In other words, the amount of money paid as the penalty, plus the interest that accrues thereon, should equal the amount of interest that SBA would have earned on the original debentures. This would constitute adequate legal consideration. See B-223329, October 17, 1986 (66 Comp.Gen. 51).

However, under the NAIC proposal, MESBICs would pay the required prepayment penalty, without ant interest, over a 10-year period, thus ignoring the "substantial difference" between the present value of money and its discounted value a 10-year period. If SBA agreed to this proposal, after the 10-year period had elapsed and the prepayment penalty was fully paid, SBA would have substantially less money, assuming all other factors remain the same, than would be the case if it had not agreed to the proposal. /4/ In these circumstances, we believe the purported consideration that SBA would receive for agreeing to reduce the interest rate on these debentures is essentially illusory, consisting, in reality, of nothing more than the payment of a lesser sum of money in exchange for a greater sum. This does not constitute adequate legal consideration. accordance with the foregoing, we agree with SBA that it does not have the authority to agree to either of these refinancing proposals.

Unless released earlier by you or your staff, this opinion will be available to the public 30 days from today.

Sincerely yours, /1/ By letter dated October 21, 1987, a Committee staff member furnished us with a copy of this proposal and requested us to include an analysis of its legality in our opinion.

/2/ Specifically, section 317 of the Act provides that for the first 5 years of the term of a debenture purchased by SBA from a section 301(d) licensee (MESBIC), the interest rate "shall be the greater of 3 per centum or 3 percentage points below the interest rate * * *" that is applicable to debentures issued by small business investment companies (SPICs) that do not qualify as MESBICs under section 301(d) of the Act

/3/ While our decision in that case did not specifically address limits on the Administrator's authority under 15 U.S.C. Sec. 634(b)(7), SBA's submission to us, as quoted in the decision, cited that provision as providing support for its position that it had authorized to modify the guarantee agreement by waiving the requirement that a loan was not covered by SBA's guarantee until the fee was paid. Our decision concluded that SBA had no such authority.

/4/ This point is conceded in a background paper your staff furnished to us dated August 7, 1987, that was prepared by NAIC regarding this proposal, which states that the government could lose as much as $3.4 million if the proposal was implemented (or somewhat less, depending on the maturity dates of the existing debentures).

In accordance with the foregoing, we agree with SBA that it does not have the authority to agree to either of these refinancing proposals.

Unless released earlier by you or your staff, this opinion will be available to the public 30 days from today.

Sincerely yours,

/1/ By letter dated October 21, 1987, a Committee staff member furnished us with a copy of this proposal and requested us to include an analysis of its legality in our opinion.

/2/ Specifically, section 317 of the Act provides that for the first 5 years of the term of a debenture purchased by SBA from a section 301(d) licensee (MESBIC), the interest rate "shall be the greater of 3 per centum or 3 percentage points below the interest rate * * *" that is applicable to debentures issued by small business investment companies (SPICs) that do not qualify as MESBICs under section 301(d) of the Act

/3/ While our decision in that case did not specifically address limits on the Administrator's authority under 15 U.S.C. Sec. 634(b)(7), SBA's submission to us, as quoted in the decision, cited that provision as providing support for its position that it had authorized to modify the guarantee agreement by waiving the requirement that a loan was not covered by SBA's guarantee until the fee was paid. Our decision concluded that SBA had no such authority.

/4/ This point is conceded in a background paper your staff furnished to us dated August 7, 1987, that was prepared by NAIC regarding this proposal, which states that the government could lose as much as $3.4 million if the proposal was implemented (or somewhat less, depending on the maturity dates of the existing debentures).