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January 19, 2011

Firm News for January 2011: Best Practices: Documenting SBA Loan Disbursements

By: Starfield & Smith

The SBA requires lenders participating in the 7(a) loan program to fully document all loan disbursements in accordance with SBA regulations. In the guaranty purchase context, a lender’s failure to adequately document each disbursement of an SBA-guaranteed loan is one of the top reasons for a repair or denial of the guaranty. Lenders should always be mindful of their obligations to properly document each disbursement and ensure that disbursed funds are used in accordance with the allotted use of proceeds in the Loan Authorization in order to preserve the SBA guaranty. When financing the purchase of equipment or inventory, lenders must obtain copies of invoices, purchase orders, and copies of cancelled checks or evidence of wire transfers, as applicable. In the context of loans used to finance leasehold improvements or construction, lenders must make sure that all draws are properly documented by the construction manager or supported by invoices.

For each initial disbursement, all lenders are required to complete the SBA Form 1050 Settlement Sheet, which both the lender and the borrower must sign. Subsequent disbursements must be documented in detail and attached to the initial Form 1050 Settlement Sheet in the loan file. Documentation for each disbursement should clearly indicate 1) the recipient of each disbursement, 2) the date and amount of each disbursement, and 3) the purpose of each disbursement. Finally, every disbursement must be documented with supporting evidence which clearly establishes that loan proceeds were used for the purposes outlined in the Loan Authorization. While accounting for the entirety of each disbursement may seem cumbersome, documentation evidencing proper use of loan proceeds is required in Tab 5 of every SBA guaranty purchase request. The lack of such evidence is likely to lead to a repair or denial of the guaranty.

If making a disbursement for working capital when working capital is not a designated use of proceeds in the Loan Authorization, lenders should make sure the disbursement does not violate the 10% or $10,000 rule set forth in the Loan Authorization. (“Lender may disburse to Borrower as working capital only, funds not spent for the listed purposes as long as those funds do not exceed 10% of the specific purpose authorized or $10,000, whichever is less”).

Lenders should never disburse loan proceeds solely to pay the SBA Guarantee, but may disburse loan proceeds designated for closing costs and/or working capital to cover closing costs and the SBA Guarantee Fee. Furthermore, an Eligible Passive Company is never eligible to receive working capital funds.

While determining exactly what supporting documentation will properly evidence the use of loan proceeds is not an exact science, the SOP 50 10 5 (C) provides lenders with guidelines at pages 231-232. Joint payee checks, copies of receipts, invoices, or other supporting documentation clearly marked by the vendor or contractor as “paid”, and evidence of wire transfers to vendors with copies of invoices are all considered acceptable supporting documentation for the use of loan proceeds. In the absence of additional documentation, checks made directly to the lender or borrower, unpaid offers, orders or invoices, or cancelled checks from the borrower do not clearly establish that loan proceeds were used for the stated purposes outlined in the Loan Authorization. If unable to properly document the use of loan proceeds, a lender must document the file with a detailed explanation of the efforts made to obtain such documentation and the reason for its unavailability.

For more information on other issues related to documenting SBA loans or submitting guaranty purchase requests, contact the author at cevans@starfieldsmith.com or 215-542-7070.