Best Practices: Flood Insurance Requirements under 50 10 5 (H)

As we’ve seen over and over the last few years, communities across the United States have been devastated by storms and resulting floods that have destroyed homes and businesses alike. Undoubtedly, some of those businesses begun or were sustained with SBA loans. Therefore, it is crucial for SBA Lenders to understand Flood Insurance and, when it needs to be obtained under the guidelines of SOP 50 10.

Under SOP 50 10 5 (H), flood insurance must be obtained when any collateral is located in a special flood hazard area, or flood zone. SBA flood insurance requirements are based on determinations made by FEMA on the FEMA Form 086-0-32, Standard Flood Hazard Determination Form. In order to determine whether the collateral is in a flood zone, a search must be performed on the address or land parcel number, and the FEMA form will provide confirmation that the address or parcel number is either in a flood zone, or not. The National Flood Insurance Program (NFIP), a FEMA initiative, determines the requirements of when flood insurance is required by the federal government, and for our purposes, by the SBA.

These requirements also pertain to condominiums and cooperative units. The SOP states that any requirements put forth by the NFIP apply with equal force to these types of buildings. Lenders must require the individual owner of the particular unit to obtain flood insurance for the unit, and the condominium or cooperative association to obtain insurance for the exterior of the entire building.

Under the NFIP, if any part of a building that is being used as collateral to secure the loan is located in a flood zone (zone “A” or “V”), the lender must require the Borrower to obtain flood insurance for the building. Failure to do so would almost certainly result in a repair or denial if the loan was to default as a result of a flood, or if flood damage resulted in a loss to the lender or SBA.

Similarly, if there is any tangible non real estate collateral, such as equipment, fixtures or inventory (“Personal Property Collateral”) located within a building that is in a flood zone, whether or not the building is collateral for the loan, the Lender must require the Borrower to obtain flood insurance for the Personal Property Collateral. There is little flexibility in this requirement, and once again, a failure to obtain the requisite insurance would most likely result in a repair or denial in the event of a flood.

The SBA does provide Lenders with some flexibility and the capability to make a business decision regarding flood insurance when the Personal Property Collateral is located in a building that is not collateral for the loan. The Lender may waive this requirement when the building is not collateral if the Lender uses prudent lending standards to determine that flood insurance was not economically feasible or not available, and includes a written justification explaining why the insurance was not economically feasible, or the steps they took to determine that it was not available. Lenders must be careful to properly document their file when choosing to waive this requirement, or will risk the guaranty.

Another consideration for the Lender is the amount of flood insurance that is needed. The SBA requires the amount of insurance obtained by the Borrower to be the lesser of the insurable value of the property or the maximum limit of available coverage ($500,000, per NFIP guidelines). The insurance coverage must also contain either a Mortgagee clause, or Lender’s Loss Payee clause, in favor of the Lender. These clauses must contain language that protects the Lender from any action or failure to act by the debtor or owner of the insured property that would invalidate the interest of the Lender. Any failure to obtain the proper insurance amount and the endorsements required by the SBA could result in a repair or denial of the guaranty.

It is important for Lenders to know what the SBA requires in order to protect the guaranty. An important part of protecting the guaranty is obtaining the proper insurance as required, and that includes knowing when flood insurance is required and what language must be included in the coverage to meet the requirements of the SOP 50 10 5 (H). Flood insurance is not just about protecting your collateral, it’s also about protecting your guaranty. For more information regarding flood insurance and other SBA related due diligence matters, contact Tim at tdlauro@starfieldsmith.com.