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April 14, 2011

Firm News for April 2011: Best Practices: SBA Standby Agreements

By: Ethan W. Smith, Esq.

In certain circumstances, an SBA lender may need to obtain a Standby Creditor’s Agreement in connection with its SBA loan closing. Typically, Standby Agreements provide for the deferment of payments on either seller debt or debt owed to the principal(s) of the borrower in order to accomplish one of two goals: (1) for credit related reasons such as deferring payment on debt to improve the cash-flow for underwriting purposes; or (2) to qualify debt as equity injection. Regardless of the reason for the Standby Agreement, the SBA has certain requirements regarding these agreements that Lenders should keep in mind when processing and closing its SBA guaranteed loans.

SOP 50 10 5(C) sets forth the guidelines for Standby Agreements on page 212. The SOP states:

“…Lender may use SBA Form 155 or its own Standby Agreement Form. A copy of the note must be attached to the standby agreement… Standby Creditor must subordinate any lien rights in collateral securing the Loan to lender’s rights in the collateral, and take no action against Borrower or any collateral securing the Standby Debt without lender’s consent” (emphasis added).

While these requirements are relatively brief, they are very important, as the failure to follow these guidelines could lead to a recommendation for a repair or denial of the SBA guaranty in a default scenario. The implementation of a few best practices will help protect a lender from this liability.

First, revision C to the SOP mandates that a copy of the standby note must be attached to the Standby Agreement. Often when the standby debt is shareholder debt or other debt that is owed to the principal of the business, there is not a note to evidence the debt which only exists on the applicant’s financial statements. In such event, the borrower must create a note and provide a copy to the lender.

Second, regardless of the reason for the Standby Agreement, the note should contain language that reflects the standby provisions, or, at the very least, makes reference to the fact that the note is subject to the provisions of the Standby Agreement. By including this language in the standby note, any future third party purchaser or assignee of the standby note will be placed on notice of the standby provisions, making it easier for lender to enforce these provisions against such third parties in the future, if necessary.

Third, while the SBA requires the standby creditor to subordinate its lien rights to lender’s lien, SBA form 155 does not contain any subordination language. It is therefore incumbent on the lender to have the Standby Creditor sign a separate subordination agreement in addition to Form 155, or to use its own form that includes the necessary subordination language. Lenders should be mindful that if they use their own forms, that these forms must satisfy all of the Standby Agreement requirements set forth in the Loan Authorization.

By employing these best practices when dealing with SBA Standby Agreements, Lenders will avoid unnecessary and costly litigation as well as recommendations for repairs or denials of the SBA guaranty. For more information on Standby Agreements or other SBA documentation or closing issues, contact Ethan at 267-470-1186, or at esmith@starfieldsmith.com.