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April 27, 2016

Best Practices: Collateral Securing Guaranties

by Janet M. Dery

Under Subpart B, Chapter 4, Section II of SOP 50 10 5(H), a lender must use commercially reasonable and prudent practices and procedures to identify property which may be collateral for its 7(a) loan, which practices and procedures are at least as thorough as those used by the lender for similarly-sized non-SBA guaranteed commercial loans. The determination should be based upon the circumstances of the particular loan and the requirements contained on pages 165 – 167 of the SOP. Additionally, if the loan is refinancing debt, the loan must be secured with at least the same collateral and same lien priority on such collateral as the debt that is being refinanced.

The SBA does not require a lender to take any collateral on a 7(a) loan up to $25,000.00. For 7(a) loans from $25,001.00 to $350,000.00, the SBA requires at a minimum a first lien on all of borrower’s assets financed with loan proceeds and a lien on the borrower’s fixed assets (real estate, machinery and equipment). If it would do so for a similarly-sized non-SBA guaranteed commercial loan, the lender may also lien the trading assets of the Borrower and residential or investment real property owned by the guarantor(s).

When 7(a) loans are for more than $350,000.00, the lender must collateralize its loan to the maximum extent possible up to the loan amount. Therefore, the lender must take a lien on fixed assets, and if such assets do not fully secure the loan amount, the lender must also lien the trading assets of the Borrower and residential or investment real property owned by the guarantor(s) unless the equity in such real property is less than 25% of the fair market value of the real property. If the loan is still not fully secured, the lender may take additional collateral from any individual or entity guarantor(s) of the loan, if available.

The SBA’s requirements for protecting the value of collateral securing the 7(a) loan is the same for any guarantor-owned collateral as it is for the borrower-owned collateral and regardless of lender’s lien position. These requirements include:

  • obtaining proof of hazard insurance in an amount that equals full replacement cost of such collateral (or maximum insurable value if full replacement cost is not available) and containing a Mortgagee (for real property) and/or Lender’s Loss Payable (for personal property) clause in favor of lender, with at least 10 days prior written notice to lender of policy cancellation (SOP Subpart B, Chapter 5, Section II.A.);
  • if the real or personal property is located in a flood zone, obtaining proof of flood insurance in an amount equal to the lesser of the insurable value of the property or maximum limit of coverage available, containing a Mortgagee (for real property) and/or Lender’s Loss Payable (for personal property) clause in favor of lender (SOP Subpart B, Chapter 5, Section II.C.); and
  • obtaining an executed Landlord’s Waiver that provides lender with the ability to access the leased premises to facilitate the liquidation of any personal property collateral located at such leased premises (SOP Subpart B, Chapter 5, Section V.B.)

A lender’s failure to protect the guarantor-owned collateral as required by the SOP could be the basis of the SBA’s repair or denial of a guaranty purchase request if such collateral is: (i) damaged or destroyed and the lender is not entitled to any insurance proceeds due to failure to obtain required insurance coverage; or (ii) taken and/or liquidated by a landlord under any security interest landlord may have in the personal property under its lease or applicable state law. So, to protect its guaranty, the lender should always comply with the SOP’s collateral requirements for all collateral securing its loan.

For more information on guarantor-owned collateral, please contact Janet at 267-470-1189 or at jdery@starfieldsmith.com.