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May 11, 2016

Best Practices: The “Art” of Ordering Public Records Searches

by Ethan W. Smith

SBA Lenders often wonder about what public records searches they must order as part of their due diligence when processing an SBA loan. Unfortunately, the SBA does not specify any requirements for performing searches, instead specifying the requirements for collateral and underwriting and leaving it up to lenders to engage in “prudent lending” to fulfill the SBA’s requirements. While this lack of express requirements may seem challenging to lenders, the reality is that every loan is different, and a static set of search requirements will not provide the degree of flexibility that lenders will need to adequately protect the interests of both the lender and the SBA. Invariably, such an approach will likely be either over-inclusive, thereby wasting borrower’s money on unnecessary searches, or under-inclusive, thereby exposing the lender and the SBA to unnecessary risk.

When approaching the question of what searches should be ordered, lenders should keep in mind that there are essentially two rationales for ordering searches of the public records as part of a lender’s due diligence: 1) confirming lien position; and 2) credit.

With respect to lien position, the analysis is relatively straightforward – searches should be ordered that will confirm that the lender has obtained the requisite lien position on the collateral set forth in Section H. of the Loan Authorization. Accordingly, searches should be ordered on all parties, and in all locations, to confirm that the lender’s lien will only be subject to those liens permitted in the Authorization. What this means for lenders, is that if they are required to take a first lien on Business Personal Property (“BPP”) that will be perfected by the filing of a UCC-1 Financing Statement, the lender must order searches to confirm that its UCC will not be subject to any other liens. You will need to run a UCC search (ideally, after you have pre-filed your UCC against the borrower) against the borrower and, in a change of ownership, against the seller and any other party pledging BPP collateral. Lenders will also need to run tax-lien and judgment searches against these same parties to ensure that no tax or judgment liens have been levied against the BPP collateral. For real property collateral, a title insurance commitment or title search must be performed in the county where the real property is located to ensure the lender’s lien will have the requisite priority. Lenders would do well to keep in mind that a title search will include tax-liens and judgments against the owner of the real property so as to avoid ordering duplicative searches.

With respect to credit considerations, the analysis is less straightforward. What searches do you need to run when your lien position is not at issue? What are the credit issues that a prudent lender should be concerned with? Across the spectrum of risk, lenders vary from one extreme of merely relying on a credit report to address any issues that may affect the lender’s credit decision, to the other extreme of ordering a full set of searches, including pending litigation and other non-lien related searches, on each and every party to the loan. Lenders must balance the cost of such searches with the potential harm of relying on a credit report which may or may not be entirely accurate. On the one hand, lenders do not want to put borrowers to unnecessary expense. Nor do they want to create any “false-positive” issues. On the other hand, lenders might want to know about a pending litigation or discharged bankruptcy against the borrower or its principals since it may say something significant about the parties’ ability to repay the loan in the future. Ultimately, whatever policy the lender decides to employ, it should be at least as stringent as its policy for non-guaranteed loans. By becoming proficient at the “Art” of ordering searches, lenders can minimize expenses while providing maximum protection to themselves and the SBA guaranty.

For more information on SBA search requirements, contact Ethan Smith at esmith@starfieldsmith.com or at 267-470-1186.