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Amend the Borrower’s Tax Return and Help Pay Back A Loan (Part 2) – Directing the Borrower’s Tax Refund

In the last post, we discussed the newly expanded net operating loss (NOL) carry back period, and explained how for some borrowers, the new law could generate “found money” that could be put to good use – such as paying down bank debt (one of my favorite uses!!). As with all gift horses, however, it is necessary to carefully examine this one so that the cash ends up where it ought to go.

First, it is necessary to understand that a creditor cannot take a security interest in a taxpayer’s right to a tax refund. We’ve seen unwary lenders naively assume that the IRS is going to honor a security agreement and a UCC-1 financing statement. The usual result is the tax refund lands in an account at another bank and is used to pay “more pressing” obligations. Because a secured creditor cannot take a security interest in the right to a tax refund before the refund is issued, the lender must take steps to channel the tax refund so that once paid out by the Government, it goes to pay down bank debt.

The JMBM Special Assets Team™ has developed a technique that minimizes the substantial risk that a borrower will divert the tax refund and put it to other uses. This technique requires the taxpayer/borrower to elect direct deposit of the refund into a bank-controlled blocked account, which is subject to the bank’s perfected security interest. While not foolproof, the use of a direct deposit into a blocked account reduces the risk of diversion and increases visibility to the bank.

We prepare an agreement among bank, borrower and guarantors that obligates the taxpayer/borrower (or the taxpayer/guarantor, as may be the case) to file the appropriate election with IRS to apply the NOL carry back, to file the appropriate amendments to its old tax returns by a date certain (using tax professionals selected by the borrower, but approved by the bank), and to elect direct deposit into the blocked account. The agreement also requires copies of all forms filed with IRS to be promptly delivered to the bank. Meanwhile, the borrower makes a nominal deposit into a blocked account at the bank so that everything is ready when the tax refund is issued. The final key is that the agreement must also authorize the bank to apply the tax refund, once received in the blocked account, against the loan.

A concern exists that a taxpayer/borrower might try to change the direct deposit information in connection with an electronic refund after the election for direct deposit is filed. A taxpayer can call to notify the IRS of incorrect direct deposit information; however, because of the timing of the refund, it may be difficult for the IRS to stop the payment. The IRS needs a few weeks lead time to stop an electronic refund. Beware, however, that if enough time is available, the IRS can block a direct deposit of a refund, and issue a paper check instead.

We’ve seen that happen as well. Should the tax refund proceeds be diverted, the result is, of course, a default under the loan and a borrower who has willfully deceived its lender – and we all know how to deal with a borrower who intentionally diverts money away from its lender.

The bottom line is that lenders may be ignoring a cash windfall that is available to companies who did well over last several years but performed poorly in 2008 and 2009. Take the time to go through your troubled credits to see whether your borrowers might be entitled to claim a tax refund under the expanded NOL carry back rules. Require those companies who are candidates to consult with their tax advisors and report back to the bank, preferably with a letter from the tax advisor. Don’t rely on a handshake to assume you will get the proceeds from the tax refund. Instead, consider a process like the one I have outlined above. Hope this helps get some loans paid down or off!!

This is Dick Rogan, bank lawyer and author of, signing off for now. Join us again soon to check out what’s new in the World of Workouts.

Year after year, day after day, workout professionals in the know rely on JMBM’s Special Assets Team™ to handle problem commercial and real estate loans. Whatever problem loans you have, chances are, we’ve seen it. Give us a call.


Our Perspective. JMBM represents commercial banks, special servicers, private lenders, asset-based lenders, hard money lenders and factors. We help lender clients throughout the United States craft business and legal solutions to their commercial and real estate troubled loans. For more information, please contact Dick Rogan at, or (415) 398-8080.

Richard A. Rogan is Chair of the JMBM Special Assets Team™. He also serves as the co-managing partner of JMBM’s San Francisco office and co-chair of its Bankruptcy Practice Group.

JMBM’s Special Assets Team™ has represented hundreds of lenders in California and throughout the United States. We regularly appear in bankruptcy courts, district courts and superior courts. We are proud to serve as trusted counsel and advisors who look for a business solution and try to help lenders find the best possible resolution for each troubled loan. Whether a loan is being newly documented, restructured or litigated, JMBM’s Special Assets Team™ has the skill, know-how and experience to solve your problem in a practical no-nonsense way.

NOTE TO CONSUMERS: As a matter of Firm policy, JMBM does not represent individual consumers who have disputes with their lenders. Many lenders have specialized consumer workout professionals who have the time to help consumer borrowers. There are many fine attorneys who specialize in representing consumers. Individuals with consumer lending problems should contact a lawyer or law firm who specializes in consumer insolvency and bankruptcy in their local area. When in doubt, we suggest you contact your local bar association’s Lawyer Referral Service. [For example, see Bar Association of SF or LA County Bar Association Lawyer Referral Services]

JMBM does not provide legal advice to consumers, and cannot respond to consumer inquiries.