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April 6, 2011

Firm News for April 2011: Title Insurance: Endorsements For Specific Situations – Access

By: Amy R. Brownstein, Esq.

Several months ago I discussed variations of the standard endorsements that are obtained in connection with most loan transactions requiring title insurance. This month, I would like to focus on two endorsements that may be desirable to address the situation where there is potentially a lack of access to property. These endorsements are the ALTA Endorsement 17 (Access and Entry) and the ALTA Endorsement 17.1 (Indirect Access and Entry).

Upon occasion, we receive a title commitment that includes an exception for possible lack of access of the property to a public street. Such an exception immediately raises the possibility of a marketability issue, i.e., the possibility that, in the event of a default, it may negatively impact the value of the lender’s collateral by making it impossible or prohibitively expensive to sell a property to which there is no legal access. In such a situation, it is advisable to obtain title insurance that insures access to the property. Either the ALTA Endorsement 17-06 and 17.1-6 may be useful in such a circumstance.

The ALTA Endorsement 17 insures that the property has access to a public street. Specifically, it insures that the land abuts a named street, that the street is physically open and publicly maintained, that the land has actual pedestrian and vehicular access to and from the street, and that the insured has a right to use existing curb cuts or entries along the abutting street. This endorsement will only be available if the title company is able to determine, by inspection, survey or otherwise, that the requisite access actually exists.

When the ALTA Endorsement 17 is not available, i.e., if the property does not have access to a public street, the ALTA Endorsement 17.1 might be obtainable. This endorsement insures that the land abuts an easement that has access to a named street, that the street is physically open and publicly maintained, that the easement provides the land with actual pedestrian and vehicular access to the street, and that the insured has a right to use the easement and the existing curb cuts along the portion of the street abutting the easement for access to the property. The easement may be one that already exists across the land of the borrower or of a third party, or the borrower may need to enter into an easement agreement with an adjacent land owner in order to obtain access to his or her property.

Either the ALTA Endorsement 17 or 17.1 provide a lender with assurance that there is a legal means of access to the property. If access is obtained by way of an easement, it would be advisable to review the terms of the easement agreement to determine if it raises any additional issues, such as maintenance or insurance obligations or liability for costs related to the easement area. Additionally, in the event that any portion of the property on which the easement is located is proposed to be sold, the easement agreement should be reviewed again to confirm that the sale will not disrupt the easement rights.

For more information on endorsements and other title insurance related matters, contact Amy at abrownstein@starfieldsmith.com, or 215-542-7070.

Firm News for March 30, 2011:
Best Practices: Financing Residential Space
By: Katie G. O’Brien, Esq.

Often, SBA lenders receive requests to finance the purchase or the construction of improvements to real property that are mixed use – containing both commercial and residential space.

The SBA rules regarding whether SBA financing may be used to purchase, refinance or construct a building which will be used for business purposes, but which also contains residential space are somewhat unclear and often leave lenders wondering if their proposed project is eligible, or not. This article will examine the different scenarios involving the financing of residential space with an SBA loan and will discuss the various eligibility concerns that lenders must keep in mind when processing these loans.

Resident Owner or Manager

The SOP 50 10 5(C) (“SOP”) at page 147, clearly states that SBA loan proceeds may be used to purchase a building or construct a new building that includes residential space when (1) the residential space does not exceed 49% of the total property, (2) the nature of the business requires a resident owner or manager, and (3) the residential space is an essential part of the business. The SOP sets forth a horse-breeding facility as an example of a type of business that requires a resident owner or manager to be on-site at all times to care for the animals.

But what about a funeral director who lives at a funeral home? Or a dentist who lives on-site to treat patients needing emergency services at night and on weekends? Because there is no bright line rule as to when residential space is considered to be an essential part of the business, Lenders must clearly document their files with their analysis and reasoning and should get as much supporting documentation as possible from the applicant to demonstrate the essential nature of the residential space.

Third Party Residential Tenant(s)

The SBA allows residential space to be leased to a third party residential tenant in certain circumstances. However, the SOP is unclear whether all residential space, whether occupied by a resident owner or manager or leased to a third party, must be an essential part of the business if the premises are financed with SBA proceeds. The SBA states that residential space must be an essential part of the business when loan proceeds will be used to purchase or construct a building which will contain a residence for the owner or manager, but that this restriction does not also apply to third party residential leases.

Accordingly, SBA loan proceeds may be used to purchase or construct a building, a portion of which contains residential space that will be leased to a third party tenant, as long as the following requirements are met:
• Occupancy by the operating company –

o If an existing building, the business must occupy 51% of the rentable property (as defined below) and may lease up to 49% to third parties;
o If constructing new building, the business must occupy 60% of the rentable property and may permanently lease up to 20%, and temporarily lease up to 20% (but must use some of this temporarily leased property within 3 years and all of it within 10 years)

• The rental income must be independently verified if is included in the Lender’s repayment analysis.

Rentable property is defined as “the total square footage of all buildings or facilities used for business operations” excluding vertical penetrations (i.e. stairways, elevators, etc.) and including common areas (i.e. lobbies, vestibules, bathrooms, etc.). Rentable property excludes outdoor areas.

Because this analysis involves an eligibility determination, an incorrect determination could lead to a complete denial of the SBA guaranty. Therefore, it is imperative for Lenders to do a thorough analysis and clearly document their decisions. When in doubt about an eligibility determination, it is always safest for Lenders to submit their loans through general processing. For more information on SBA documentation and closing issues, contact Katie at 267-470-1207 or kobrien@starfieldsmith.com.