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June 10, 2015

Best Practices: Payoff Letters

by Katie O'Brien

In an article published in our newsletter on March 11, 2015, I discussed the importance of lenders obtaining the correct lien position on the collateral securing their loans. One suggestion I gave was to pre-file Uniform Commercial Code (“UCC”) financing statements. However, sometimes a lender’s UCC search reveals that another secured party already has a lien on a borrower’s or guarantor’s personal property. Sometimes the obligation secured by this lien will be subordinated or will be paid off and the corresponding UCC financing statement will be terminated prior to closing. But other times, the debt associated with the UCC financing statement is being refinanced and paid off at closing. Similarly, a UCC search on a seller in a business acquisition loan may reveal a UCC financing statement that needs to be paid off at closing out of seller’s proceeds of sale.

In these situations, lenders must get written confirmation from the secured party of record that the secured party will release its security interest in the collateral set forth in the UCC financing statement and that the secured party will terminate its UCC financing statement (or will give the debtor or lender the authority to terminate the UCC financing statement) upon receipt of the proceeds being paid at closing. This is typically addressed in the payoff letter, but it can often take several requests to obtain satisfactory written confirmation from the secured party of record. Thus, when the pressure to close the loan is upon us, it is sometimes tempting to rely on borrower’s, guarantor’s or seller’s word that the UCC financing statement will be terminated and that the collateral set forth in the UCC financing statement is not securing any other loans other than those being paid off at closing. While such statements may be well-intentioned, debtors do not always understand that the loan being paid off at closing may be cross-collateralized with another loan remaining in place or that the UCC financing statement in question may be related to another debt not being paid off at closing. Therefore, a borrower, guarantor’s or seller’s statements can not substitute for written confirmation from the secured party of record that the UCC will be terminated.

Once the lender has received such confirmation from the secured party, it can still be difficult to actually obtain the UCC-3 termination from the secured party that was paid off at closing. However, under Section 9-513 of the Uniform Commercial Code, a secured party must send a debtor a termination statement for a filed financing statement or file the termination statement in the filing office within 20 days after the secured party receives an authenticated (or signed) demand from a debtor, if there is no obligation secured by the collateral covered by the financing statement, and there is no further commitment to make an advance, incur an obligation or otherwise give value. Therefore, the lender may need the cooperation of the borrower, guarantor or seller post closing to make an authenticated demand to the secured party paid off at closing to release its lien on the collateral and provide a UCC-3 termination statement. Lenders may want to have borrowers sign a post closing affidavit or other agreement in which borrower agrees to provide lender with the applicable UCC-3 terminations post closing.

Failure to obtain the required lien position is the number one reason for repairs of the SBA guaranty. Obtaining payoff letters which confirm that a secured party will release its security interest in collateral and terminate UCC financing statements is crucial for lenders to obtain the proper lien position on their collateral. For questions regarding payoff letters or obtaining proper lien positions, contact Katie at kobrien@starfieldsmith.com or at 267-470-1207.