HB-3-3560 

CHAPTER 10: COMPLIANCE VIOLATIONS, 

DEFAULTS, AND WORK-OUT AGREEMENTS 

[7 CFR 3560.453]

10.1 INTRODUCTION 

When routine monitoring of projects reveals noncompliance with program requirements, 

the Field Office must take immediate steps to notify the borrower and state of the need for timely 

corrective actions. To protect the security value of a property, it is in the Agency’s best interest 

to work with the borrower to resolve any compliance violations. Resolving situations of 

noncompliance is the main subject of this chapter. 

Loan Servicers should be firm in dealing with the borrower or the borrower’s 

representative in matters of compliance violations. Because the management agent is not the 

party ultimately responsible for the loan, it is imperative that the borrower be directly apprised of 

and fully understands the consequences of default. Therefore, whenever any written servicing 

notice is sent to a management agent who is not the borrower, the borrower must also receive a 

copy of the notice. Loan Servicers need to employ courtesy, cooperation, and sound judgment 

when interacting with borrowers and management agents in any servicing situation. 

A noncompliance situation is often resolved or deterred through a work-out agreement. 

This is a plan for resolving or deterring noncompliance that is developed and presented by a 

borrower to the Agency for approval. The Agency may or may not approve the proposed workout agreement. This chapter discusses the Agency requirements for work-out agreements. 

10.2 ADDRESSING COMPLIANCE VIOLATIONS AND DEFAULTS 

Borrowers are in default of their loan or grant agreements whenever they are not in 

compliance with the terms of the loan or grant agreement. Such defaults may be of a monetary 

nature, such as when borrowers do not make their loan payments, or of a nonmonetary nature, 

such as when borrowers have not maintained projects properly. Default may be triggered by 

events that are beyond the borrower’s control, such as changing markets that lead to prolonged 

vacancies. Nevertheless, being in default is a serious situation for a borrower and requires that 

every effort be made to resolve it. 

Defaults may lead to foreclosure, loan liquidation, or the assessment of civil penalties. 

One significant step that can be taken toward resolving the default is for the Agency and the 

borrower to agree to a work-out agreement. A work-out agreement may also be used in certain 

cases to avert a default situation. The Agency will not pursue enforcement against a borrower in 

default (monetary or nonmonetary) if an approved work-out agreement is in place and on 

schedule. Thus, it is in the borrower’s best interest to work with the Agency to resolve 

compliance issues through a work-out agreement. 

A work-out agreement is a proposal that is submitted by the borrower to the Agency for 

approval of changes in project operations, for additional time to restore compliance, or for 

servicing actions to assist in correcting identified deficiencies. There are several servicing 

options available under a work-out agreement, and the borrower and Loan Servicer should 

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consider all of them and evaluate which are the most appropriate for a specific problem project. 

This chapter explains how borrowers may enter into default of their loan or grant 

agreement and the different types of defaults that may occur. It describes the process by which 

the Loan Servicer notifies the borrower of compliance violations and the options available to 

remedy the noncompliance. The chapter then discusses work-out agreements and includes a 

separate section on Special Note Rents (SNRs), which enable borrowers to reduce rents to attract 

tenants. By reading this chapter, the Loan Servicer will understand how to systematically work 

with the borrower to resolve noncompliance, when it is appropriate and feasible for a borrower to 

enter into a work-out agreement, what are the required terms of the agreement, and how to 

monitor borrower compliance with the work-out agreement. 

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SECTION 1: TYPES OF DEFAULTS [7 CFR 3560.452]

10.3 OVERVIEW 

Borrowers in violation of the terms of the loan or grant documents for the project or 

applicable Federal regulations, including a work-out agreement, who fail to fully correct a 

deficiency by a date specified by the Agency in a written notice are in default of their loan or 

grant documents. 

Defaults can be of a monetary or nonmonetary nature. The Agency will initiate 

appropriate enforcement actions against any borrower in default. 

10.4 MONETARY DEFAULT 

A project that is in monetary default is defined as one that is delinquent for more than 60 

days. Projects with monetary violations include those for which the loans have been accelerated 

and of which the borrowers are in bankruptcy. A project is delinquent when a loan payment is 

more than 10 days past due. Project payments are due on the date specified on Form RD 3560-

52, Promissory Note. 

Monetary default may warrant the development of a work-out agreement or initiation of 

enforcement actions by the Agency that include termination of a management agreement, 

receivership, suing for performance, collection of unauthorized assistance, or denial of a rent 

increase. 

10.5 NONMONETARY DEFAULT 

Nonmonetary defaults include, but are not limited to, failing to maintain project reserves, 

failing to adequately maintain the physical condition of the property, failing to comply with 

environmental mitigation measures, occupying units with ineligible tenants without prior Agency 

approval, charging incorrect rents, failing to meet fair housing requirements, and failing to 

properly report to the Agency. A borrower will be considered in nonmonetary default if the 

identified deficiencies are not cured within 60 days of notification. 

Attempts to resolve nonmonetary defaults should be handled whenever possible at the 

Field Office level with appropriate guidance and assistance from the State Office. 

Environmental concerns, such as failure to comply with mitigation measures, should be reviewed 

with the State Environmental Coordinator for further guidance. The State Director should 

counsel with the Office of General Counsel (OGC) for advice, if needed, in servicing those cases 

where nonmonetary defaults cannot be resolved at the Field Office level. These actions may 

include liquidation of the account, see Chapter 12. 

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SECTION 2: CONDITIONS OF CONCERN, COMPLIANCE 

VIOLATIONS, AND DEFAULTS 

10.6 AGENCY CLASSIFICATION SYSTEM 

The Agency has developed a classification system that describes the servicing status of 

each operational multi-family housing project. This classification system provides a picture of 

the status of the housing portfolio and flags those projects that need special servicing and/or 

monitoring. Exhibit 10-1 shows how projects are classified. 

The Agency’s classification system is to be used to focus servicing efforts. Projects 

classified as a D or a C should receive first priority when allocating resources to address 

portfolio concerns. Internal supervisory reviews should primarily examine how Loan Servicers 

are working to address projects with servicing concerns. 

The classification system will be maintained on the Multi-Family Integrated System 

(MFIS). Servicing officials are responsible for making sure that MFIS is current and accurately 

reflects a project’s servicing status. The supervisory visit and engagement review are key events 

for updating a project’s servicing status. Chapter 9 of HB-2-3560 describes the Agency review 

process in more detail. 

Exhibit 10-1 

Classification System of Operational Projects 

Class D includes: 

 Projects in nonmonetary default having an unresolved violation for 

more than 60 days from the date of Handbook Letter 301 (3560), 

Servicing Letter #1; and 

 Projects in monetary default that are delinquent for more than 60 

days 

Class C includes: 

 Projects with an unresolved finding or violation not associated to a 

Workout Plan and/or Transition Plan; and 

 Projects with an unresolved violation for less than 60 days from the 

date of Handbook Letter 301 (3560). 

Class B includes: 

 Projects with findings or violations associated to an approved workout plan and/or transition plan that is on schedule. 

Class A includes: 

 Projects with no unresolved finding or violation. 

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10.7 FINDINGS 

A finding is determined when the Agency “finds” that a borrower is not operating in 

accordance with the loan or grant agreement, with Agency regulations, or with applicable local, 

state, or Federal laws. When the Agency discovers a deficiency in a project that requires 

correction but is not the equivalent of a violation or an unacceptable summary level finding 

during an inspection or review report, the Agency must notify the borrower of this finding. 

Depending on the severity of the finding, the servicing official may advise the borrower of the 

finding either orally, or in writing through a monitoring letter. Should the finding not be 

corrected after at least one written notice has been sent to the borrower with a specified date by 

which the finding must be corrected, the Loan Servicer must determine whether the issue should 

be elevated to a violation status. When the Servicing Office concludes that the finding should be 

viewed as a violation that could lead to a default, the Loan Servicer must begin the process of 

issuing the servicing letters described in Paragraph 10.10. 

10.8 VIOLATIONS 

A violation is a finding that the Servicing Office escalates because of its severity or 

because of the type of servicing effort that will be needed to obtain compliance. When the 

Agency designates a finding as a violation, it indicates a willingness to pursue the finding to the 

point of acceleration to have it corrected. Compliance violations include, but are not limited to, 

any unacceptable summary level finding on the physical inspection report, project management 

and occupancy review, or engagement review that could be updated at any time. Examples 

include failing to make required contributions to project reserves, failing to adequately maintain 

the exterior physical condition of the property under Agency standards, failing to comply with 

environmental mitigation measures, occupying units with ineligible tenants without prior Agency 

approval, charging incorrect rents, and failing to properly report to the Agency. 

10.9 KEY STEPS IN ADDRESSING COMPLIANCE VIOLATIONS AND DEFAULTS 

The Agency must respond quickly and systematically whenever a project is identified as 

being in noncompliance with program requirements. In responding to a noncompliance 

situation, the Loan Servicer will take some or all of the following steps and update the servicing 

status on MFIS: 

 Notify the borrower of the violation and request corrective action; 

 Meet with the borrower to discuss the problem and possible servicing actions to 

remedy the problem; 

 Review any proposed work-out agreement developed by the borrower and suggest 

acceptable servicing actions if appropriate; 

 Issue a problem case report; and 

 Initiate enforcement actions to motivate the borrower to restore compliance. 

These steps are discussed in detail in the following sections. 

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10.10 NOTIFICATION TO BORROWER OF SERVICING PROBLEMS 

The Agency must notify the borrower using formal servicing letters that state the need for 

corrective action to be taken. It is not the Agency’s responsibility to come up with solutions to 

the problems. Rather, it is the borrower who must identify what corrective actions will take 

place immediately or over time through a work-out agreement. 

The Field Office will use a series of servicing letters to communicate with the borrower 

until the problem is resolved. Copies of the letters must be sent to the management agent of the 

property that is the subject of the letters if the owner is not the management agent. Exhibit 10-2 

shows the sequencing of these servicing letters. 

Handbook Letter 301 (3560) serves to trigger the start of a 60-day period for 

nonmonetary violations and a 45-day period for monetary violations, at the end of which the 

borrowers are in default of their loan agreement if the situation has not been resolved. 

Resolution may take the form of action proposed by the borrower and approved by the Agency, 

or it may take the form of enforcement actions instituted by the Agency when the borrower fails 

to respond or responds inadequately. 

A. Preliminary Notification 

When a borrower becomes delinquent on a payment, an automatically generated 

Delinquency Billing Statement is mailed to the borrower. The borrower will be in default 

if the loan payment is not made in full within 60 days of this notice. If the borrower does 

not submit the loan payment before the payment is 30 days past due, the borrower 

receives Handbook Letter 301 (3560). If the borrower submits the full payment, 

including any applicable late fees (see Chapter 4, paragraph 4.4 on late fees) the Loan 

Servicer does not take any further servicing action. 

During an on-site monitoring visit the monitors should meet with the borrower to 

review the initial results of the visit, including a discussion of compliance violations. See 

Chapter 9, paragraph 9.6 B of HB-2-3560 for more information about on-site monitoring 

visits. 

Example: Borrower B’s project has several crumbling steps in the stairwell. Since 

this represents an unacceptable condition of exterior maintenance, which is a compliance 

violation, the Loan Servicer notifies the borrower during the on-site visit on this 

violation.

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Exhibit 10-2 

Sequence of Servicing Letters 

Letter Nonmonetary Monetary 

Preliminary 

Notification 

The Loan Servicer informs the 

borrower of violations during a 

wrap-up meeting of a monitoring 

visit. 

A Delinquency Billing Statement 

is automatically sent to borrower 

when the borrower becomes 

delinquent (10 days past due). 

Letter #1 Sent upon evidence of violation and 

no later than 30 days after the 

monitoring visit. Date of letter 

signifies beginning of 60-day period 

to default. 

Sent no later than when payment is 

35 days past due. 

Letter #2 Sent sometime after 15 days if 

borrower fails to respond or responds 

inadequately to Letter #1. Notifies 

borrower of date by which they will 

be considered delinquent if violation 

not corrected (60 days after date of 

Letter #1). 

Sent after payment is 45 days past 

due. Notifies borrowers of date by 

which they will be classified a D 

project (60 days after payment due 

date). 

Letter #3 Sent at least 60 days after date of 

first letter and at least 15 days after 

Letter #2 notifying borrowers that 

they are in default and warning of 

enforcement action if problem is not 

corrected within 15 days. 

Sent 60 days after payment due 

date notifying borrower that the 

Agency will take legal action to 

cure the default and warning of 

enforcement action if payment is 

not made within 15 days. 

B. Borrowers with Multiple Servicing Issues 

If a borrower is in violation in several different areas, the Handbook Letter 301 

(3560) should identify all the violations. If sent, Handbook Letter 302 (3560) would 

reference “ongoing compliance violations” to cover multiple servicing issues. The series 

of letters continues until each violation has been resolved. 

A servicing letter may cite conditions of concern (see Paragraph 10.7) along with 

compliance violations. However, only the cited compliance violations could lead to a 

default status if left unresolved. If the borrower resolves all violations within 60 days, 

they will not default even if the conditions of concern have not been resolved. 

If at any time the Agency discovers that a borrower who has received a servicing 

letter has another problem that warrants a servicing letter, the letter will be sent, 

triggering a second series of letters. These letters can run separately from and 

independent of the first series of letters or they may be combined at some point. 

However, it is important that the Loan Servicer track the separate violations cited by the 

date of each Handbook Letter 301 (3560) so that Handbook Letter 303 (3560 correctly 

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identifies the violation that has resulted in the default by a certain date. 

10.11 EVALUATING THE PROJECT 

When the Loan Servicer has sent two servicing letters to notify a borrower of problems 

with a project, the Loan Servicer must evaluate the project to establish whether it is in the 

Agency’s best interests to attempt to work with the borrower to preserve the subject project. The 

Loan Servicer will use the procedures outlined in Chapter 6. Such an evaluation should come 

before any meeting with the borrower so that the Loan Servicer is familiar with the project and 

its status. 

10.12 MEETING WITH THE BORROWER 

When the borrower proposes a work-out agreement in response to Handbook Letter 301 

(3560), or when Handbook Letter 302 (3560) must be sent, the Loan Servicer must request a 

meeting with the borrower. The purpose of the meeting is to identify and agree upon the 

servicing problem, establish the underlying causes of the problem, and begin to develop the 

parameters of a work-out agreement. The Loan Servicer will discuss possible Agency servicing 

actions. 

It is the responsibility of the borrower, not the Agency, to propose and develop an 

acceptable work-out agreement. However, borrowers may delegate authority to their 

management agent to develop a work-out agreement. A borrower may do this by signing a 

statement in the management plan or certifying in a letter to the Agency that the management 

agent has the authority to act on their behalf. 

Once the work-out agreement is proposed, the Loan Servicer may propose servicing 

actions that are appropriate and acceptable to the Agency. Section 4 of this chapter describes the 

special servicing actions available to Loan Servicers. 

10.13 SELECTING SERVICING OPTIONS 

The Agency may agree to various servicing options to resolve the compliance problems 

depending upon the circumstances of the noncompliance. The deciding factor will often be the 

quality of management. 

A. Poor Management and Noncompliance with Program Requirements

Where management is poor and/or there is noncompliance with program 

requirements, the Agency may agree to: 

 Borrower training. Training of resident managers may be charged as a project 

expense if directly related to improving project operations; 

 New management. Hiring or changing resident managers or management agents; 

 Improving maintenance. Change to normal, preventive, and long-term maintenance 

and repair programs to make the project more marketable; 

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 Improving budget and record keeping and using monthly reports. Major 

expenditures should be reviewed for appropriateness; and 

 Improving outreach and marketing. Project marketing plans, including the 

Affirmative Fair Housing Marketing Plan, should be reviewed and updated as 

appropriate. 

B. Acceptable Management, but Marketability and Cash Flow Problems 

Where management is acceptable, marketability and cash flow problems may be 

resolved through one or more of the following actions. 

 Upgrading project desirability by: 

 Performing necessary and preventive maintenance; 

 Improving curb appeal at the project; 

 Improving security for tenants, such as installing deadbolts and more lighting; and 

 Improving communication between management, residents, and the community. 

 Reducing expenditures by reviewing the appropriateness of operating and expense 

levels in relation to services rendered. It is not intended that management fees be 

adjusted as a condition for consideration of servicing options. Operation and expense 

levels may be reduced by: 

 Containing operation and maintenance costs that will not disrupt project 

operations; 

 Renegotiating contracts with suppliers of material and services; and 

 Temporarily deferring noncritical maintenance, provided tenant safety and project 

marketability are preserved. 

 Temporarily reducing or deferring reserve contribution levels. 

 Increasing revenues by: 

 Injecting non-project revenues; 

 Requesting rental assistance; or 

 Permitting temporary incentives to improve occupancy. 

 Permitting a release of the rental assistance payments that would ordinarily go for 

debt service to be used for project operation and maintenance. 

C. Acceptable Management, but Lack of Project Demand 

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Where management is acceptable, but there is a lack of project demand or a problem 

of obtaining and/or retaining eligible tenants, the problems may be resolved by: 

 Granting occupancy waivers; 

 Changing the project designation; and 

 Implementing a SNR, see Section 6 of this chapter. 

10.14 THE PROBLEM CASE REPORT 

The Loan Servicer must develop a problem case report using Form RD 3560-56 Report 

on Real Estate Problem Case for the State Director if the Loan Servicer has sent a borrower 

three letters requesting corrective action to a compliance violation and the borrower has failed to 

provide an adequate response. 

Field office servicing officials will forward the problem case report describing the 

violations of Agency requirements by the borrower to the State Director along with 

recommended enforcement actions. The time frame for this action should be within 120 days of 

concluding that efforts to achieve compliance have been unsuccessful. 

The State Director will review the problem case report and respond to the Field Office 

within 30 days of receipt of the problem case report indicating the action to be taken. The State 

Director’s response will be either: 

 An agreement with the Loan Servicer’s proposal for enforcement; or 

 A directive for alternative servicing. 

10.15 ENFORCEMENT ACTIONS 

If a borrower fails to provide an acceptable work-out agreement or fails to comply with 

the work-out agreement, the Agency will initiate enforcement actions when liquidation is not in 

the Government’s or the tenants’ best interests. This might occur in the case of defaults that do 

not affect the health and safety of tenants and where the cost of liquidation is significant relative 

to the violation, or where the costs of liquidation and providing adequate tenant protections is 

high. Available enforcement actions that the Agency can take include: 

 Termination of the management agreement. The Agency may terminate the 

management agreement and require the borrower to hire new management; 

 Receivership. The Agency may appoint a third party to manage the project. When 

this becomes necessary, the State Director must contact OGC for assistance and 

provide them with alternative management agents; 

 Suing for performance under the loan document. The procedures for Civil 

Monetary Penalties are provided in Chapter 9.27. In such cases, the Office of 

General Counsel will provide assistance; and 

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 Collection of unauthorized assistance. The procedures outlined in Chapter 9 will 

be followed. 

A. Liquidation 

When it is in the Government’s or the tenants’ best interest to liquidate, or if 

enforcement actions have been unsuccessful, the Agency will initiate liquidation through 

either: 

 Voluntary liquidation; or 

 Foreclosure. 

The Agency may proceed directly to liquidation if doing so will not adversely affect 

tenants. Normally this is reserved for cases where the borrower has abandoned the 

project, or a partnership has been dissolved, leaving no legal entity in place to oversee the 

property. Properties where serious health and safety concerns exist are the most likely to 

go straight to enforcement or liquidation. Chapter 12 provides details on liquidation. 

B. Debt Settlement 

If the property is worth less than the outstanding Agency debt, it may be in the 

government’s best interest to settle the debt using its debt settlement procedures. 

Compromise offers to settle outstanding debts may be part of a work-out agreement 

accompanying a transfer. Chapter 12 provides further details on debt settlement. 

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SECTION 3: DEVELOPING A WORK-OUT AGREEMENT 

[7 CFR 3560.453]

10.16 OVERVIEW OF WORK-OUT AGREEMENTS 

A work-out agreement is a proposal submitted by a borrower to the Agency for approval 

of changes in project operations, additional time to restore compliance, or other special servicing 

actions to assist in correcting identified deficiencies. A borrower may submit a work-out 

agreement at any time in response to Agency notification of compliance problems or prior to that 

if the borrower feels that noncompliance is imminent. 

The work-out agreement may be a very simple one-page plan for resolving a single 

problem, or it may be a more complex document of several pages that describes several plans of 

action to resolve a more complicated problem. If a borrower does not develop a work-out plan, 

the Loan Servicer must develop a problem case report, in accordance with Paragraph 10.14. 

Acceptable and successful work-out agreements depend upon some flexibility on the part 

of the Loan Servicer and the borrower, thoughtful and project-specific servicing, and thorough 

and consistent monitoring that serves to track the progress of the agreement. 

10.17 CONDITIONS WARRANTING A WORK-OUT AGREEMENT 

Serious compliance deficiencies that cannot be resolved promptly may warrant the 

development of a work-out agreement. Such conditions may reflect a financial, physical, fair 

housing, or occupancy deficiency. 

A. Financial Deficiencies 

Financial deficiencies that may require a work-out agreement include: 

 Inadequate cash flow to meet project needs. Cash flow should be adequate to pay 

Agency debt, meet reserve requirements, pay taxes, pay insurance, pay other project 

expenses, and pay any authorized return on owner investment when earned; 

 Projects that are 60 days past due; 

 Seriously underfunded reserve accounts that cannot be brought up to required levels 

within a normal budget cycle or where unauthorized withdrawals have been made; 

and 

 Borrowers who have not adhered to program requirements such as paying taxes, 

maintaining insurance, or submitting required financial information. 

B. Physical Deficiencies 

Physical deficiencies that may require a work-out agreement include failure to 

maintain decent, safe, and sanitary housing opportunities for residents and maintenance 

that has been deferred for so long that it has become a financial burden to the project. 

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C. Fair Housing Deficiencies 

Fair housing or Section 504 violations and problems with tenant certification and 

project occupancy requirements may warrant the development of a work-out agreement. 

D. Occupancy Deficiencies 

Serious vacancies that threaten property viability where management can furnish 

evidence that they have made efforts to increase occupancy may warrant a work-out 

agreement. 

10.18 ELIGIBILITY FOR WORK-OUT AGREEMENTS 

The Agency will consider work-out agreements only for properties: 

 That are deemed to be program property; or 

 Whose owners demonstrate a commitment to correcting property deficiencies. 

A. Program Property 

The Loan Servicer must establish whether the project is suitable for the program 

using the guidance provided in Chapter 6. If the project is deemed to be non-program 

property, a work-out agreement must not be considered. 

B. Owner Evaluation 

An owner who has not maintained compliance with prior work-out agreements and 

has historically ignored Agency requests for corrective actions must not be considered 

eligible for a work-out agreement. 

10.19 CONTENT OF A WORK-OUT AGREEMENT 

All work-out agreements must be in writing and executed by the borrower, or the 

borrower’s designated representative, the management agent who manages the project (if 

different from the borrower), and the Agency before they take effect. The work-out agreement 

must correct all deficiencies that have been identified in a project. 

Exhibit 10-3 lists the information that must be included in a work-out agreement. 

10.20 CONDITIONS PLACED ON THE BORROWER 

Borrowers must forgo and cannot recoup the annual return to owner for the budget year 

in which a work-out agreement is in effect. 

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Exhibit 10-3 

Recommended Format for Servicing Work-out Plan (SWP) 

Background information. Provide history and describe past goals and accomplishments.

Description of the problem(s) to be solved. Identify project weaknesses and needs making sure to cover: 

 Compliance deficiencies (e.g., delinquent amounts, underfunded reserves, nonpayment of taxes, deferred 

maintenance, unacceptable tenant file records, noncompliance with accessibility and fair housing issues, 

etc.); and 

 Serious financial concerns (e.g., high vacancies, inadequate cash flow, high Operations & Maintenance 

(O&M) expenses.). 

Underlying causes of problem. Attempt to identify the cause of the problem. Attempt to recognize when 

problems identified are symptoms or the results of the same underlying causes. 

Overview of plan to correct problem. Provide a summary of the plan and identification of key assumptions used 

in projections. 

How the plan will work. Provide details on how the plan will work with attached supporting documentation (i.e., 

budget), when appropriate. A timetable for completing the work-out plan and key components of the plan (i.e., 

plan calling for capital improvements should identify the improvement proposed, cost with supporting estimates, 

source of funds, and completion dates). 

Anticipated results. Clearly identify the goals to be reached. Have periodic, measurable interim goals to 

determine that full implementation is on track. 

Written work-out plans. All work-out plans must be in writing and must be executed by the borrower or the 

borrower’s designated representative, and Rural Development. A copy of the executed work-out plan will be 

placed in the case file; copies will be given to the borrower, management agent, and the State Director. 

Time frames for implementing and completing the plan. Prior to approval, all plans must be evaluated on 

whether the plan realistically achieves the objectives of the loan. All plans must be reevaluated at the end of the 

two-year period. If the plan includes a time frame for completion of more than two years, the plan must be revised 

and reexecuted at the end of each year to determine if satisfactory progress has been made. 

Monitoring working plans. The following statements must be a part of the plan immediately above the signatory 

line: 

“The management agent is responsible for making quarterly progress reports with regard to plan 

compliance to Rural Development and the borrower. The first report will be due no later than 

100 days from the date of Rural Development approval and every 100 days thereafter.” 

Check appropriate box: 

 Initial SWP 

 Renewal of SWP 

 Renegotiated SWP. There have been ______ previous SWPs on this account. 

10.21 PRIORITIES IN MEETING EXPENDITURES 

In developing work-out budgets for projects experiencing cash-flow difficulties, the 

following priorities will be used: 

 First priority is to meet obligations to the prior lienholder, if any; 

 Second priority is for critical project operating and maintenance expenses, including 

taxes and insurance; 

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Reserve Account Deficiencies 

When seriously underfunded reserve levels 

are involved in an extended work-out time 

period, the Loan Servicer should reassess the 

reserve level for the project and establish a new 

reserve level, if appropriate. A capital needs 

assessment can be useful to make this 

determination. If re-funding the reserve to its 

new level will require more than two years, the 

borrower and Loan Servicer may want to 

consider additional work-out terms so that the 

project is not in continual need of requiring a 

work-out agreement. 

 Third priority is for Agency debt payments; 

 Fourth priority is for reserves; and 

 Fifth priority is for other project needs. 

10.22 LENGTH OF TERM AND AUTHORITIES 

A. Term of Work-Out Agreement 

The maximum term of a work-out 

agreement is two years. All 

agreements must be reevaluated 

annually as well as at the end of the 

two-year period. The evaluation is 

based on whether the plan realistically 

achieves financial viability and 

otherwise meets the objectives for 

which the loan was made. If an 

approved work-out agreement calls for 

actions that extend beyond a two-year 

period, borrowers must submit an 

updated and if necessary, revised 

work-out agreement to the Agency for 

approval. The updated work-out 

agreement must be submitted to the Agency 30 days prior to the expiration of the workout agreement in effect. The Agency may reexecute the agreement if satisfactory 

progress has been made. 

Normally, work-out agreements should not exceed two years, especially if a plan calls 

for less than full payment on an Agency loan, or less than full contribution to the reserve 

account. Plans not meeting these criteria are normally not considered as viable and 

feasible. 

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B. Authority to Approve Work-Out Agreements 

1. Field Offices 

Delegated Field Office staff can approve work-out agreements that correct 

deficiencies within 12 months, except when the agreement includes a special servicing 

action per Section 4. 

2. State Offices 

Delegated State Office Staff approves any work-out agreements that: 

 Are for longer than 12 months; 

 Require contributions to reserves of less than that which is required plus 10 percent of 

the delinquent amount; or 

 Include loan adjustments or write-downs. 

3. National Office 

 State Office must have submitted to National Office for concurrence when borrowers 

are requesting reduced or zero RHS loan payments. The following documents must be 

submitted to the National Office: 

 Copy of the proposed Work-Out Agreement; 

 Proposed Budget as part of the Work-Out Agreement; 

 Pro Forma Budget once the Work-Out Agreement is completed; and 

 Recommendation justification from State Office. 

10.23 AGENCY REVIEW AND APPROVAL [7 CFR 3560.453(b)]

Work-out agreements are a tool that the Agency can use to work with the borrower to 

effectively resolve defaults if the borrower is acting in good faith to actively propose realistic 

corrective actions. Approval of a work-out agreement is not guaranteed to a borrower. Failure to 

approve a work-out agreement is not an adverse action by the Agency because the Agency is not 

required to grant approval of modifications to the terms of the loan for borrowers in default; thus, 

the Agency is not taking away any borrower rights by not approving the work-out agreement. 

Therefore, failure to approve a work-out agreement is not appealable by a borrower, although the 

Agency’s decision may be reviewed. 

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A. Evaluation of Work-Out Agreement 

The Agency is under no obligation to offer or agree to any special servicing actions 

contained within a proposed work-out agreement. In evaluating the borrower’s proposal, 

the Agency will accept work-out agreements that meet the following criteria: 

 The proposed actions effectively correct the deficiency; 

 The proposed time frame for correction is reasonable and realistic for correcting the 

deficiency; 

 There is evidence of adequate borrower commitment of resources, considering the 

cause of the problem, (e.g., a lesser commitment may be appropriate if the problem 

was caused by circumstances beyond the borrower’s control); 

 The proposed special servicing actions for the Agency (e.g., reamortization, 

writedown) is in the interest of the Government and the tenants, and the costs of 

 continuation are not more than the costs of liquidation and providing tenant 

protection; and 

 The proposed actions are consistent with the borrower’s management plan. If the 

proposed actions are not consistent, the management plan must be updated. 

B. Procedures Following Approval of Agreement 

The approved work-out agreement will be signed and dated by the Approval Official, 

the borrower, and the management agent, if different from the borrower, and will be 

attached as an addendum to the management plan for the project.

10.24 CANCELING A WORK-OUT AGREEMENT 

A work-out agreement may be canceled by whoever approved it 10 days after 

discovering a borrower’s noncompliance with its terms. If the official who originally approved 

the work-out agreement is not available, then the official who has assumed that individual’s 

responsibilities will be responsible for canceling the agreement and notifying the borrower. 

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SECTION 4: SPECIAL SERVICING ACTIONS 

10.25 SPECIAL SERVICING ACTIONS THAT MAY BE A PART OF A WORK-OUT 

AGREEMENT 

A number of special servicing actions may be proposed and approved as part of a workout agreement. As shown in Exhibit 10-4, these servicing actions may be divided into two broad 

categories: changes in project operations and changes to the loan account. This section 

describes other servicing actions, most of which are less extreme. 

A. Servicing Actions to Change Project Operations 

The borrower may propose one or more servicing actions that will produce a change 

in project operations. Some of these actions are discussed in detail in other sections. 

Exhibit 10-4 

Special Servicing Actions That May Be Part 

of an Approved Work-out Agreement 

Changes in Project Operations 

 Rent changes and/or preparation of a 

new budget 

 Occupancy waivers 

 Temporary incentives to improve 

occupancy 

 Special note rents (SNRs) 

 Changing management agent or 

management plan 

 Changing project designation 

 Transfer of ownership 

 Substitution of partners 

Changes to the Loan Account 

 Loan reamortizations 

 Loan adjustments (writedowns) 

 Loan consolidation 

 Deferral of payments 

 Prepayment/compromise offer 

 Providing rental assistance (if 

available) 

 Recasting the entire loan (i.e., “starting 

fresh”) 

1. Rent Changes or Preparation of a New Budget 

To achieve financial stability, the borrower may propose a new budget that shows a 

change in rents or operation costs. In evaluating the request, it may be appropriate for the 

Agency to analyze the current market in which the project is located to see whether the 

project rents compare favorably with rents for similar properties in the market. Rent 

incentives will be allowed as described in paragraph 10.25 A.3 of this section, but the 

change and accompanying budget will be conditionally approved by the Agency subject 

to meeting the requirements in Agency regulations, see Chapter 7 of HB-2-3560. If the 

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Agency receives comments from tenants that warrant a different decision from the one 

made when the work-out agreement was conditionally approved, the Agency must inform 

the borrower of these discoveries and make any needed adjustments to the conditionally 

approved budget. 

In reviewing these changes, the Loan Servicer must evaluate both short- and longterm budget projections so as to establish whether the project is likely to achieve its 

financial goals during the work-out period, and whether the project is likely to achieve 

and maintain financial viability in the long term. The Loan Servicer must evaluate 

whether projections show repayment ability after the work-out agreement objectives are 

met based on realistic vacancy, rent rate, and/or reamortization assumption. 

Any projected capital improvements shown in the budget must be accompanied by 

statements that describe the work to be done, the estimated costs with supporting 

material, the projected time frame for completing the work, and the source of funds to be 

used for the improvements. 

2. Occupancy Waivers 

When a project is experiencing high vacancies and eligible tenants are not available, 

the borrower may request to temporarily solve the problem by renting to ineligible 

tenants. Ineligible tenants might be individuals whose incomes or family sizes are above 

the maximum limits or who do not meet an occupancy requirement, such as an age limit. 

A request to rent to ineligible tenants may be approved by the Loan Servicer based on 

the following determinations: 

 There are no eligible persons on the waiting list; 

 The borrower has made a diligent but unsuccessful effort to rent any vacant units to 

an eligible tenant; and 

 The borrower will continue to seek eligible tenants and will submit the following to 

the Field Office; 

 Form RD 3560-29; and

 A report of efforts made to locate eligible tenants. 

The borrower must agree to the following conditions: 

 The units may be rented to ineligible tenants for no more than one year, following 

which the lease must convert to a monthly lease. A statement to this effect must be 

included in the lease; 

 Tenants who are ineligible because their household income exceeds the maximum for 

the project will be charged the Agency-approved SNR, if applicable; and 

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Temporary Incentives 

to Improve Occupancy 

1. Security deposit reductions or waivers 

and extended security deposit 

payment period. 

2. Reduced rents in the form of rebates, 

coupons, or a temporary agreement. 

3. Free rent. 

4. Reduced or free utilities. 

5. Referral fee payments. 

6. Rent-up gift to tenant, such as a 

savings bond or gift certificate. 

 Without Agency approval, management may assign a larger or smaller unit than the 

household needs if the household is otherwise eligible. Tenants must agree to transfer 

to a correctly sized unit when one becomes available and must pay all costs 

associated with moving. A statement to this effect must be included in the lease. 

3. Temporary Incentives to Improve Occupancy 

The borrower may request temporary incentives to improve project occupancy. 

These incentives may not exceed the life of the work-out agreement. The Agency may 

grant such incentives when project management has been acceptable and under the 

following conditions: 

 The project is encountering 

unacceptable vacancy levels. 

 The incentives are short-term, modest, 

and consistent with program objectives. 

 Recipients are given a clear 

understanding of the extents and limits 

of the incentives. 

 The use of incentives is fully accounted 

for on project budgets and annual 

reports. 

 Occupancy incentives will be paid from 

the following sources: 

 Non-project sources; 

 Forgone return to owner; and 

 Project funds when it can be shown to be cost-effective, which means that the 

revenues derived will outweigh the costs of providing the incentives. 

4. Special Note Rents 

The borrower may request a SNR to reduce the note rate rent to attract tenants who 

can afford to pay more than 30 percent of their incomes in rent and utilities but who will 

not pay the existing note rate rent. This servicing action is discussed in detail in Section 

6 of this chapter. 

5. Changing the Management Agent or Management Plan 

Where poor management is evidenced by a record of failing to comply with Agency 

requirements, the borrower may elect to change management. Where the Agency has 

notified the borrower of the need to change management, financial incentives under 

work-out agreement provisions may not be approved until the borrower changes 

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management or agrees to change management within a reasonable time frame. 

6. Changing the Project Designation 

When a market has changed such that the type of tenant who would qualify for the 

project is no longer available and vacancies are resulting, the borrower may request a 

change in project designation. The State Director will consider such a change when the 

following information has been provided: 

 The complete borrower case files will be submitted together with the Loan Servicer’s 

specific recommendations and analysis of the present and long-term situation; 

 Market feasibility documentation, which may include inquiry lists from the project or 

waiting lists at other nearby and similar properties, which shows that other tenants are 

available to occupy the project. Market feasibility documentation must also clearly 

indicate that the present long-term marketability of the project is significantly 

changed from the original market and must include the appropriate demographic 

information that reflects the population trends in the area. The market feasibility 

documentation must also show if the demand is for the bedroom-sized units in the 

project or if different sized units would be more desirable; 

 A summary of all servicing actions taken by the Agency to aid the borrower in 

maintaining the present designation; 

 A summary of all actions taken by the borrower to effectively market the units to 

potential eligible tenants; 

 A summary of the impact the change will have on any existing tenants, rent subsidy 

needs, and the community as a whole; and 

 A summary of any needed or required physical modifications and analysis of cost 

feasibility to complete the modifications, including modification to unit sizes in terms 

of number of bedrooms. 

7. Transfer of Ownership 

In some cases, the only means of addressing project concerns is through replacement 

of the borrower. Some reasons that may require a transfer of ownership include: 

 Illness or death of a borrower; 

 Financial difficulties that cause a borrower to terminate his or her business operation; 

and 

 Fraudulent activity, as determined by the Office of the Inspector General (OIG). 

Where work-out agreements call for a change in the borrower, the Agency may 

temporarily approve financial concessions contingent upon the borrower agreeing to seek 

a transfer of ownership. The borrower must agree to provide evidence that ownership 

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replacement is being actively pursued. Should ownership replacement not be achieved 

within an agreed-upon time frame, liquidation of the account may be appropriate. 

When a transfer occurs as a result of noncompliance, the transferee (new borrower) 

must provide a plan for bringing the project into compliance as part of the application 

package. For example, the loan payments and reserve account may be behind schedule. 

The transferee provides a plan that identifies the source of funds to meet these conditions. 

Chapter 7 provides the details on approving and processing transfers of ownership. 

8. Substitution of Partners 

The borrower may request a substitution of general partners as a way to inject new 

resources into the borrower entity. Chapter 5 provides the details on approving and 

processing substitution of partners. 

B. Changes to the Loan Account 

Proposed servicing actions may require changes to the loan account such as those that 

are described in Chapter 11. 

1. Deferral of Payments 

Deferring any debt payment to the Agency is an extreme measure that should be used 

as a last resort. Deferring a portion of the Agency debt and using this deferred amount to 

build up reserve funds may only be approved when the funds are being used to pay 

identified critical project needs. For example, when a roof must be replaced within the 

next two years, the work-out agreement may call for deferring payments in an amount 

equal to the cost of replacing the roof and this amount will be deposited into the reserve 

account. The critical need must be identified and closely monitored to ensure 

compliance. 

Deferral of payment by the Agency should usually be accompanied by a borrower 

contribution of financial resources to the project. 

Deferring debt payments should not exceed two years. National Office concurrence 

must be obtained when borrowers are requesting reduced or zero loan payments. 

2. Change of Payments 

Scheduling loan payment in accordance with the borrower’s repayment ability. The 

provisions must be documented. The issuance of Form RD 3560-29A, Multiple Family 

Housing Statement of Payment Due, will normally be suppressed during the period in 

which a work-out agreement calling for less than the normal full scheduled installment is 

effective. To suppress issuance of Form RD 3560-29A, process by using the appropriate 

screen on the Automated Multi-Family Housing Accounting System (AMAS); see the 

AMAS manual for specific instructions on how this is done. Upon expiration of the 

work-out agreement, a review will be conducted to determine any further servicing 

actions that may be appropriate (e.g., reamortizing, rescheduling, executing a new 

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servicing plan and/or supplementary payment agreement that may call for higher than 

normal payments, preparing a problem case report, etc.). As long as a borrower is 

meeting the provisions of an approved work-out agreement calling for less than full 

installments, late fees will be waived. 

3. Prepayment 

A borrower may offer to pay their loan in full, ahead of the scheduled loan repayment 

date and exit the program. In such an event, the project will no longer be a part of the 

Multi-Family Housing program, will no longer be subsidized by the Agency, and will no 

longer be subject to Agency regulations and procedures. Chapter 15 provides the details 

on approving and processing prepayment requests. 

4. Voluntary Conveyance 

Voluntary conveyance is a method of liquidation by which title to security is 

transferred to the Federal Government. The State Director is authorized to approve 

voluntary conveyance of property if the total indebtedness, including prior and junior 

liens, does not exceed their approval authority. Chapter 12 provides the details on 

approving and processing an offer of voluntary conveyance. 

5. Provision of Rental Assistance 

Where there is servicing rental assistance available, the State Director may agree to 

provide rental assistance to a project as part of a work-out agreement in order to enable 

tenants who could otherwise not afford the rents to move into a project and improve 

vacancy. 

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SECTION 5: MONITORING THE WORK-OUT AGREEMENT 

AND SUBSEQUENT SERVICING 

10.26 MONITORING WORK-OUT AGREEMENTS 

Once a work-out agreement has been developed and approved, the Loan Servicer must 

monitor the borrower’s progress and provide guidance as needed. This is an important and 

necessary component of ensuring the success of the work-out agreement. The monitoring serves 

to make sure not only that the terms of the agreement are being upheld, but that they are having 

the desired effect of moving the project back into compliance. If not, the Loan Servicer must 

work with the borrower to amend the agreement to incorporate servicing techniques that will 

achieve the desired goals or cancel the work-out agreement and move to implement enforcement 

measures. 

The Loan Servicer will conduct the monitoring in the following ways: 

 Reviewing the financial reports submitted by the borrower. These include Form 

RD 3560-7, which must be submitted on a quarterly basis and bank statements, if 

appropriate; 

 Holding quarterly meetings at the project site with the borrower to track the progress 

of the work-out agreement; and 

 Conducting supervisory visits to monitor progress with an agreement. Such visits are 

mandatory to determine if the work is being done when the work-out agreement 

includes correcting deferred maintenance or when reserve funds are being used for 

repairs. These supervisory visits should be held in conjunction with the quarterly 

meetings with the borrower. 

10.27 SUBSEQUENT SERVICING AND IMPACT ON FUTURE LOANS 

Any member of a borrower entity with a controlling interest in a property in which there 

are serious noncompliance issues and no work-out agreement is in place, or where the entity is in 

noncompliance with its work-out agreement, will not be eligible for further Agency loans. In a 

case such as this, the borrowers must make arrangements to restore compliance with Agency 

requirements and restore their financial viability. 

In cases where the borrower and the Agency work together to make an acceptable workout agreement, the borrower may be eligible to receive additional assistance after they have been 

in compliance with the work-out agreement for six consecutive months. In cases where workout arrangements cannot be made, the primary basis for denying such assistance would be based 

on the borrowers' inability to meet eligibility requirements, shown by their track record of failing 

to meet existing requirements and responsibilities for other projects. 

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SECTION 6: SPECIAL NOTE RENTS (SNR) 

10.28 OVERVIEW OF SPECIAL NOTE RENTS [7 CFR 3560.210]

When a project is experiencing severe vacancies due to market conditions, the State 

Director may allow a borrower to charge a SNR rent to attract and keep tenants who have the 

financial ability to pay more than basic rent but who will not pay the current note rate rent. An 

SNR addresses the situation where some existing and prospective tenants are not willing to pay 

30 percent of adjusted income or note rate rent because the rental rates would exceed those of 

other rental properties in the community. This action may only be taken after supervisory efforts 

by the Agency and management efforts by the borrower have not produced an acceptable level of 

occupancy. 

10.29 SNR ELIGIBILITY REQUIREMENTS 

A. Required Project Conditions 

The borrower must document that the following conditions exist in the project for the 

Loan Servicer to consider allowing an SNR to be implemented: 

 The project has been operational for at least 24 months (the borrower may request a 

waiver to this provision); 

 No more than 10 percent of budgeted expenses are reflected as unrestricted cash on 

hand, and reserve account balances do not exceed the required accumulation-to-date 

minus authorized withdrawals; 

 Over the most recent six-month period vacancy rates have averaged at least 15 

percent or the project shows revenue losses of at least 15 percent; 

 The loss of rents available is not a result of management’s failure to effectively 

market the units; and 

 Comparable rents in the area are lower than the previously approved note rate rents. 

B. Borrower Requirements 

To be eligible for the SNR, the borrower must: 

 Be in compliance with Agency regulations and encourage occupancy through good 

maintenance and positive relations with tenants; 

 Sign a statement agreeing to forgo return to owner for the duration of the SNR; 

 Submit a budget with only the minimal sufficient operation and maintenance 

expenses; 

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 Have engaged in aggressive marketing efforts, including: 

 Significant outreach efforts in the community, including, but not limited to, 

contacts listed in the AFHMP; or 

 Obtaining approval from the Agency for a servicing work-out plan, exclusive of 

SNR features, at least three months earlier. 

10.30 SUBMITTING AND PROCESSING SNR REQUESTS 

In making the request for an SNR, the borrower submits the same information as they 

would when requesting a rent change. See Chapter 7of HB-2-3560 and 7 CFR 3560.203. 

The Loan Servicer reviews the documentation from the borrower and forwards the 

information with a recommendation to the State Director, who makes the final decision. If the 

decision is to approve the SNR, the following steps will be taken: 

 Adjust the note rate column in the proposed changes to rent section of Form 

RD 3560-7 to reflect rents needed for payment to the Agency amortized at an interest 

rate that is less than the full note rate on the borrower’s Form RD 3560-52. The 

interest rate chosen may never be less than two percent. 

 Set the interest rate of the SNR budget at a level that will make project SNR rates 

comparable with community rental rates. 

 When an SNR is implemented in a Plan II Section 8/515 project, use lines 23 through 

29 of Form RD 3560-29 to report any additional payments to the reserve account 

required when HUD contract rents exceed SNR rates. 

When the Approval Official determines a request for an SNR is not justified on the basis 

of the information submitted, the Approval Official will notify the borrower in writing of the 

reason(s) why the SNR is not approved. The borrowers will be advised of their appeal rights in 

accordance with 7 CFR Part 11. 

10.31 CHANGES TO AND TERMINATION OF SNRS 

Borrowers must request changes to SNRs at the time of budget review. If the local 

market conditions have not changed since the SNR was implemented, then no change is made to 

the SNR. If the conditions have changed, then the SNR is changed accordingly. 

The borrower must notify tenants of the project in which the SNR is proposed to be 

changed just as would be done for tenants where a regular rent change request is made. 

An increase in an SNR will be handled in accordance with regular program requirements 

for a rent change. See Chapter 7 of HB-2-3560. 

An SNR is terminated when the note rate rent is regained. 

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10.32 RESTRICTION ON NEW UNITS 

While an SNR is pending or in effect, the Field Office must not review or approve any 

other projects, of any type, in the same market area. State Directors may seek National Office 

approval for a waiver from this provision when an SNR has been in effect for 24 months. 

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SECTION 7: ENFORCEMENT 

10.33 MULTI-FAMILY HOUSING ENFORCEMENT TEAM 

The Agency has established a Multi-Family Housing Enforcement Team to improve the 

Agency’s efforts to detect and eradicate fraud, waste, and abuse in the Multi-Family Housing 

program. The mission of the Enforcement Team is to protect the interests of residents; ensure 

quality housing; restore public trust in Government investments; and eliminate program fraud, 

waste, and abuse. Within the scope of its mission, the Enforcement Team provides the following 

services: 

 Performs problem property reviews including data reviews, site visits, interviews, 

reports on findings, recommendations for remedial actions, and follow-up actions to 

ensure problem resolution; 

 Coordinates multi–state reviews of problem borrowers and management agents; 

 Recommends enforcement actions to ensure borrower/agent compliance with 

regulatory and statutory program requirements; 

 Analyzes problem property data collected by Field Office Staff and provides 

feedback concerning administrative actions for Field Office Staff to pursue in relation 

to problem properties; 

 Coordinates enforcement efforts with the OIG, OGC, Department of Justice, 

Department of Housing and Urban Development, Federal Bureau of Investigation, 

and the Internal Revenue Service, as appropriate; 

 Provides technical assistance and advice to Field Office Staff;

 Develops training materials and conduct training related to problem property analysis 

and enforcement techniques; 

 Develops a standardized process to deal with problem properties and ensure 

comparable actions are applied in similar cases; and 

 Guides field staff with appropriate actions to ensure resolutions of recommendations 

from OIG audits. 

10.34 REQUESTING ENFORCEMENT TEAM SERVICES 

Activities of the Enforcement Team may be initiated by the Deputy Administrator for 

Multi-Family Housing or by a request from a State Office. 

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