November 30, 2016
Best Practices: Avoiding Preferences in SBA Lending
by Michelle Sergent Kaas
Whether processing your SBA loan through general processing (“GP”) or through the Preferred Lenders Program (“PLP”), a lender must avoid establishing a preference. See 13 CFR §§120.411. This means that a lender must protect the SBA’s interest and must not put itself in a better position than the SBA.
Pursuant to SOP 50 10 5(H), Subpart A, Chapter 1, §II(E)(3), a lender must not “take any side collateral or guaranty that would secure only its own interest in a loan.” For example, a lender cannot take title to a vehicle outside of the SBA loan or require a borrower to assign life insurance to the lender on the non-guaranteed portion of the loan. A lender must not “obtain a separate guaranty on the unguaranteed portion of the 7(a) loan without SBA’s approval, such as through a co-guaranty program or arrangement.” Additionally, a lender must not “require a borrower to purchase certificates of deposit” or require a borrower to “maintain a compensating balance not under the control of the borrower,” and must not “take a side loan which would have the effect of ensuring a risk-free or limited-risk investment on the participant’s share.”
Furthermore, lenders must not make a SBA loan and a conventional loan in a “piggyback” structure. A “piggyback” structure “occurs when one or more lenders provide more than one loan to a single borrower at or about the same time, financing the same or similar purpose, and where the SBA-guaranteed loan is secured with a junior lien position or no lien position on the collateral securing the non-guaranteed loan(s).” For example, a lender provides a $2 million SBA loan to a borrower and secures the SBA loan with a first lien position on Property A. After the SBA loan closes, the lender then provides a $1 million conventional loan to the borrower and secures the conventional loan with a second lien position on Property A and a first lien position on Property B. The lender put itself in a better position than the SBA and gave itself a preference by taking additional collateral on the conventional loan if the SBA loan was not fully secured. As another example, a lender provides a $4 million SBA loan to a borrower and secures the SBA loan with a second lien position on all business assets of the borrower. Just prior to closing the SBA loan, the lender closed on a $2 million conventional loan to the same borrower and secured the conventional loan with a first lien position on all business assets of the borrower. The lender put itself in a better position than the SBA and gave itself a preference by taking a senior lien on the business assets and leaving the SBA with a junior lien on the same business assets.
However, the SBA does not consider a shared lien position with the lender (“pari passu”) as a piggyback structure. In the first scenario above, the lender could eliminate the preference by taking a shared first lien on Property B. The lender could even take a shared first lien on Property A and Property B since shared lien positions do not constitute a piggyback structure and are therefore not a preference under the SOP. In the second scenario, the lender could eliminate the preference by taking a shared first lien on the business assets of the borrower. This can be accomplished by generating a pari passu intercreditor agreement between the lender(s). Even if the same lender provided both the SBA loan and the conventional loan to the borrower, the lender should execute a pari passu intercreditor agreement acknowledging the shared lien position(s). Also, as with every SBA loan, the lender should fully document its loan file, act ethically and exhibit good character.
For more information on avoiding preferences in SBA lending, contact Michelle at email@example.com or at 267-470-1167.