Best Practices: The Value of a Payoff Letter

Because SBA loans are often under-collateralized, the SBA guaranty is frequently the most valuable piece of “collateral” to a lender. Because of this, it is imperative that lenders avoid the common issues that can lead to impairment of the guaranty, whether in the form of a repair or a denial. Failure to obtain the proper lien position on collateral is one of the most common reasons for a repair of the SBA guaranty, but the good news is lenders can avoid this pitfall.

One way that lenders can ensure that they have the correct lien position on business personal property is to pre-file a Uniform Commercial Code (“UCC”) financing statement and obtain a search prior to closing which confirms the lender’s correct lien position. But this becomes more complicated when a pre-closing UCC search reveals secured debt that will be paid off at closing. This often occurs when loan proceeds are being used to refinance a borrower’s business debt or when a UCC financing statement filed against a seller in a business acquisition is being paid off at closing out of sale proceeds.

In these situations, lenders must get written confirmation from the secured party of record that the secured party will release its security interest in the collateral set forth in the UCC financing statement and that the secured party will terminate its UCC financing statement (or will give the debtor or lender the authority to terminate the UCC financing statement) upon receipt of the proceeds being paid at closing. This is typically addressed in a payoff letter, but it can often take several requests to obtain satisfactory written confirmation from the secured party of record. Thus, when the pressure to close the loan is upon us, it is sometimes tempting to rely on borrower’s, guarantor’s or seller’s word, or contractual obligation between the parties, that the UCC financing statement will be terminated and that the collateral set forth in the UCC financing statement is not securing any other loans other than those being paid off at closing. While such statements may be well-intentioned, debtors do not always understand that the loan being paid off at closing may be cross-collateralized with another loan remaining in place or that the UCC financing statement in question may be related to another debt not being paid off at closing. Therefore, a borrower’s, guarantor’s or seller’s statements can not substitute for written confirmation from the secured party of record that the UCC will be terminated.

Once the lender has received such confirmation from the secured party, it can still be difficult to actually obtain the UCC-3 termination from the secured party that was paid off at closing. However, under Section 9-513 of the Uniform Commercial Code, a secured party must send a debtor a UCC-3 termination statement or file the UCC-3 termination statement within 20 days after the secured party receives an authenticated (or signed) demand from a debtor, provided that there is no obligation secured by the collateral covered by the original financing statement, and there is no further commitment to make an advance, incur an obligation or otherwise give value. Therefore, the lender may need the cooperation of the borrower, guarantor or seller post closing to make an authenticated demand to the secured party paid off at closing to release its lien on the collateral and provide a UCC-3 termination statement.

Failure to obtain the required lien position is one of the most common reasons for repairs of the SBA guaranty. Obtaining payoff letters which confirm that a secured party will release its security interest in collateral and terminate UCC financing statements is crucial for lenders to obtain the proper lien position on their collateral. For questions regarding payoff letters or obtaining proper lien positions, contact Katie at kobrien@starfieldsmith.com or at 267-470-1207.