As we have noted in the past, ordering public records searches for commercial loan transactions is more an art than a science. The objective in performing pre-closing searches on SBA loan transactions, in particular, is to ensure the correct lien priority of any collateral filings for the subject loan, and to confirm there are no findings that may adversely impact the applicant’s repayment ability.
Lenders often conduct searches on borrowers, sellers, and guarantors that may include, but are not limited to (i) state and federal tax lien searches, which would reveal any liens indicating there is a past due debt obligation or unpaid taxes owed to a state or federal agency; (ii) judgment searches that would show any judgments for a monetary amount against the subject searched; (iii) bankruptcy searches to show whether any of the parties filed for bankruptcy; (iv) UCC searches to verify the existence of any liens against personal property collateral; (v) litigation searches to show the existence of any pending lawsuits against the parties; and (vi) real estate searches via an encumbrance report or title commitment to show any liens against the subject real estate or owners. What are the next steps for lenders if the search reports reveal “adverse” results?
With respect to any tax liens or judgments, lenders should require that all state and federal tax liens and general liens or judgments related to the business or parties to a SBA loan transaction are paid in full and released or satisfied prior to closing. Exceptions to such resolution may relate to federal tax obligations that are past due, but currently on an installment plan. Borrowers must provide evidence of the installment payments and obtain confirmation from the issuing agency that the installment plan is in good standing. The installment payments should be included in the financial analysis for the subject loan request.
If the search report shows a bankruptcy filing, the lender must determine whether the debtor has been discharged and confirm that there was no prior loss to the federal government, which if present, would render the subject loan ineligible for SBA financing.
If the search reveals pending litigation involving the seller, borrower or guarantor, the lender should take additional due diligence steps to gather all of the facts concerning the litigation, the current status of the litigation, the potential exposure of the defendant party, whether other sources of funds exist (outside of the subject business income) to satisfy any judgment that may be entered, and the likelihood of the defendant winning the case (in the opinion of the defense counsel). Accordingly, if a lender is unable to ascertain the above information concerning the lawsuit, it will be difficult to justify how it is “prudent” to proceed with the closing without placing the guaranty at risk, especially in the case of an early default.
If the searches reveal active UCC filings against the parties, lenders must determine whether the underlying debt will be paid off prior to or at closing, or alternatively, whether a subordination agreement is necessary to achieve the required lien priority set forth in the SBA loan authorization.
An adverse finding with respect to a real estate search or title commitment may relate to the chain of title or marketability of title. Lenders should work proactively with the title company to resolve any potential issues prior to closing.
Lenders participating in SBA’s loan programs must take commercially reasonable steps to ensure the applicant possesses sufficient financial ability to repay the loan, and to achieve the required lien priority on all collateral for the loan. Engaging in prudent lending requires lenders to order the necessary searches on all parties pre-closing and satisfactorily resolve all adverse items, prior to initial loan disbursement.
For more information regarding closing SBA loans, contact Jen at 267-470-1206 or at email@example.com.