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March 11, 2015

Best Practices: Avoiding Improper Lien Position

by Katie O'Brien

Because many SBA loans are under-collateralized, the SBA guaranty is often the most valuable piece of “collateral” to a lender.  Because of this, it is imperative that lenders avoid the common pitfalls that can lead to impairment of the guaranty, whether in the form of a repair or a denial.  Failure to obtain the proper lien position on collateral is one of the most common reasons for a repair of the SBA guaranty, but the good news is lenders can easily avoid this pitfall.

If a lender’s Credit Memorandum and the SBA Authorization require a lender to take a first lien (or second lien, third lien, etc.) on a borrower’s business personal property, the lender will need the borrower to execute a Security Agreement at closing and the lender must file a UCC-1 financing statement with the appropriate state or county office in the borrower’s state of formation.  The lender can request that the borrower grant permission to lender to pre-file its UCC-1 financing statement prior to closing.  This is most often addressed in the Commitment Letter or in a separate authorization which the borrower executes and returns to the lender.  Once lender has borrower’s consent, it should file its UCC-1 financing statement and order a search to reflect its UCC lien position.  If lender receives this search prior to closing, it can confirm whether it has the required lien position on the borrower’s business personal property collateral.  If the search reveals intervening liens which affect lender’s lien position, lender should require that borrower obtain terminations or subordinations of such liens prior to closing.

Obtaining the proper lien position on real property collateral can be more challenging because a lender can not pre-file its mortgage or deed of trust prior to closing and funding.  If the lender’s Credit Memorandum and the SBA Authorization require title insurance on real property collateral, a lender can rely on its title policy to ensure that it has the proper lien position.  A title agent will perform a date down search immediately before recording to confirm that no liens were filed of record since the date of the title commitment.  The title agent will then issue a title policy which insures the lender that it has the anticipated lien position.

If the Credit Memorandum and SBA Authorization require a title search or other evidence of lien position, the lender should perform a title search within 30 days prior to closing.  If the search reveals that the lender will have the proper lien position, the lender can proceed to close the loan and record its mortgage or deed of trust.  Once the lender’s lien instrument is recorded, the lender should order another title search on the property to confirm that no intervening liens were filed between the time of the search and the time of recording the lender’s lien instrument.  If the search reveals intervening liens, the lender should act expeditiously to resolve the issue while it still has the borrower’s cooperation (rather than post-default when the borrower may not be cooperative) by obtaining a subordination from the intervening creditor, for example, or approving a post closing change memo if a different lien position is justified.

Whether the lender’s collateral includes personal property, real property, vehicles or some other type of collateral, lenders should make sure they have the proper lien position on all collateral securing their loans to avoid a repair of the SBA guaranty.  For questions regarding guaranty purchase issues, contact Katie at kobrien@starfieldsmith.com or at 267-470-1207.