July 27, 2011

Firm News for July 2011: Best Practices: Documenting Use of Proceeds

By: Kimberly Rayer, Esq.

After confirming a Borrower’s eligibility, proving equity injection and drafting the loan authorization, disbursing 7(a) loan proceeds may seem like the easiest part of the transaction, but if a Lender lets its guard down too soon, it may find itself facing a repair or denial of the SBA guaranty down the road.

According to the SBA Standard Operating Procedures 50-10(5)(B) (“SOP”), a Lender must disburse loan proceeds in accordance with the Authorization. Failure to do so is one of the top reasons for SBA to deny liability under its guaranty. Lenders must document each disbursement of a 7(a) loan. In connection with the initial disbursement, Lender and Borrower must complete a SBA Settlement Sheet, Form 1050. Lender must document the first and all subsequent disbursements by attaching documentation evidencing the proper use of proceeds, including copies of executed settlement statements, bank statements, cancelled checks, or paid receipts, to the original SBA Form 1050 and maintain the documentation in the loan file.

The documentation must be in sufficient detail for the SBA to determine:

A) the recipient of each disbursement;

B) the date and amount of each disbursement; and

C) the purpose of each disbursement.

Joint payee checks, copies of receipts, invoices or other supporting documentation marked paid by the seller or vendor or evidence of an electronic funds transfer to a vendor along with a copy of the invoice are acceptable documentation to verify disbursement in accordance with the Authorization

If given an option, it is always preferable for a Lender to control the disbursement process and make the disbursements directly to vendors rather than reimbursing Borrower for equipment purchased prior to closing. Lender should advise the Borrower in advance of closing that requests for payment of equipment invoices/purchase orders is a more efficient process than requesting reimbursement, which requires the Borrower to provide additional documentation.

If working capital is an identified use of proceed in the Authorization, and those proceeds will be used to pay normal operating expenses (e.g., payroll, utilities, etc.), then working capital disbursements do not need to be documented in detail. However, all Lenders are subject to prudent lending requirements and, at a minimum, Lender should always follow its own internal loan disbursement guidelines for working capital.

If Lender is making a working capital disbursement and working capital is not a designated use of proceeds in the Authorization, he should make sure the disbursement does not violate the 10% or $10,000 rule set forth in the 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”).

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

As with most aspects of SBA lending, the key to remember with disbursement of an SBA guaranteed loan is to make sure the Lender’s actions and reasons for those actions are well documented. While this article primarily focused on the purchase of equipment and disbursements for working capital, the basic disbursement principals of documenting (i) who is receiving the funds, (ii) why they are receiving the funds and (iii) and when and how much they are receiving, apply to any SBA guaranteed loan disbursement.

For more information on documenting use of proceeds and other SBA closing-related issues, contact Kim at: or 215-542-7070.