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January 12, 2011

Firm News for January: Best Practices: Avoiding Repairs Through Proper Servicing

By: Ethan W. Smith, Esq.

The burden of compliance with the myriad SBA regulations, statutes and standard operating procedures can sometimes seem daunting to SBA lenders. Often lenders focus their SBA compliance efforts on underwriting and closing related issues – indeed many SBA lenders have devoted a great deal of time and resources to setting up entire SBA departments to originate, underwrite and close their SBA loans. But what happens after the closing? Many of these same lenders will then transfer their SBA loans to their servicing departments to be serviced with the rest of their commercial loan portfolio. While the SBA loans may have been properly originated, underwritten and closed, the servicing department’s unfamiliarity with the nuances of SBA servicing requirements can lead to costly guaranty repairs, or in some instances, denials.

Many of the top reasons for servicing-related repairs are not specific to SBA, and rather reflect a general weakness in a lender’s servicing policies and procedures. Issues such as failing to renew a UCC lien on business personal property pursuant to the requirements of Article 9 of the Uniform Commercial Code (financing statements must be continued within 6 months of their lapse), or failing to ensure that business liability and hazard insurance remain in full force and effect, are not unique to the SBA world. Yet, these issues are often the basis for recommendations for repairs or denials.

Other, more SBA-specific servicing related issues that frequently result in repairs include:

· Lender’s release or subordination of its lien on collateral without a sufficiently documented business justification;

· Lender’s release of a guarantor without SBA approval;

· Lender’s failure to monitor, and if needed, to maintain life insurance on a key individual that subsequently dies;

· Lender’s servicing actions that create a preference for its non-SBA guaranteed loan(s) to a borrower, which act to the detriment of its SBA guaranteed loans to the same borrower (i.e., preferred collateral positions on non-SBA loans, preferred application of payments to conventional financing over SBA financing, etc.).

One way for lender’s to minimize their risk of repairs and denials from servicing related actions is to make sure their servicing departments have copies of, and are familiar with, the SBA 7(a) Servicing and Liquidation Action Matrix (the “Matrix”) which can be found here. The Matrix is designed to address the most common servicing and liquidation related issues and to provide instruction and guidance to lenders as to what notice to, or approval from, SBA, if any, is required for a particular action. The most important issue to remember in using the Matrix is that even when a servicing action is delegated to the lender and does not require notice to the SBA, this does not mean that the lender can do whatever it wants with regard to the contemplated action. The lender must still follow prudent lending standards and must document and justify each material servicing action it takes. Failure to do so will expose the lender’s actions to scrutiny by the SBA and can lead to costly repairs.

Preserve and protect your SBA guaranty through all phases of your SBA loan and remember that a lender’s obligation to comply with SBA regulations does not end at the closing table. For more information on SBA-related servicing issues, contact Ethan at 215-542-7070, or esmith@starfieldsmith.com.