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September 7, 2011

Best Practices: Lender’s Authority to Release and Substitute Collateral

by Joseph A. Ernst

When servicing loans, SBA lenders are often unsure what servicing actions require SBA notice and/or approval. Under the SBA Servicing and Liquidation Actions 7(a) Lender Matrix, the authority to release and substitute collateral is unilaterally delegated by SBA to the lender. This means that no notice to or approval from the SBA is required when releasing or substituting collateral. There is also no limitation on the value of the collateral being released. Lenders should be cautious, however, not to mistake the breadth of this authority granted by the SBA as license to take such actions with impunity. Indeed, the burden on lenders to justify their actions in such situations is often higher than if SBA had reviewed the proposed action in the first place.

Even though lenders have full delegated authority to release or substitute collateral in any amount, lenders should ensure that there is a substantial benefit to the borrower’s business and that the collateral position of the lender/SBA remains appropriate for the financing. In addition, if a lender decides to release or substitute collateral, it should take great care to document its justification for its decision to release or substitute collateral. This documentation must thoroughly set forth the rationale for the decision made by the lender and will often include, among other things, valuations of the collateral being released and the collateral being substituted. Additionally, a discussion of how the lender handles such servicing requests for its non-SBA-guaranteed loans, and whether the proposed action is in conformance with such policy, is a critical part of the Lender’s analysis. Such documentation is crucial to the SBA’s review of the lender’s handling of the loan and the SBA’s determination as to whether the lender acted prudently and in a commercially reasonably manner, and whether the lender materially complied with all loan program requirements.

 

As there is every reason to anticipate that the Matrix will continue to evolve and be revised over time, the supporting documentation for the loan file should also include the current version of the Matrix under which the lender made the decision to release or substitute collateral. As with all actions that could be subject to scrutiny by the SBA, the documentation in lender’s file should be sufficient so that a person with no familiarity with the loan could clearly follow the lender’s decision making process from beginning to end and clearly understand lender’s rationale for each decision made.

Often, lender’s decisions regarding the substitution or release of collateral is reasonable, but its documentation of the decision is often inadequate. If the lender’s justification of its decision to release or substitute collateral is not prudent and commercially reasonable or if the documentation of such decision is insufficient, either deficiency could be the basis for a recommendation for a repair or denial of the SBA guaranty. Don’t let incomplete documentation of your servicing actions risk your SBA guaranty; document, document, document each and every servicing decision.

For more information on SBA servicing requirements or related SBA closing and servicing issues, contact Joe at jernst@starfieldsmith.com or (215) 542-7070.