Because many SBA loans are under-collateralized, the SBA guaranty is often the most valuable piece of “collateral” to a lender. Because of this, it is imperative that lenders avoid the common pitfalls that can lead to impairment of the guaranty, whether in the form of a repair or a denial. Failure to obtain the correct 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 easily avoid this pitfall.
If a lender’s credit approval documentation and the SBA Authorization require the lender to take a first lien (or second lien, third lien, etc.) on a borrower’s personal property, the borrower must execute a security agreement at closing and the lender must file a UCC-1 financing statement with the appropriate state or county office, as applicable, in the borrower’s state of formation. The lender should request that the borrower grant permission to the lender to pre-file its UCC-1 financing statement prior to closing. This is most often addressed in the commitment letter or in a separate authorization which the borrower executes and returns to the lender prior to closing. Once the lender has the borrower’s consent to pre-file, the lender should file its UCC-1 financing statement and order a search to reflect its UCC lien position. If lender receives this search prior to closing, it can confirm whether it has the correct lien position on the borrower’s personal property collateral as required by the SBA Authorization and its credit approval. If the search reveals intervening UCCs which affect lender’s lien position, lender should require that borrower obtain terminations or subordinations of such UCCs prior to closing. On the contrary, if the lender waits until the day of closing to file its UCC-1 financing statement, the lender will not know if there are any intervening liens until days or weeks after the loan is already closed – at that point, the lender’s bargaining power and control are much less than they were prior to closing and funding the loan.
Obtaining the correct lien position on real property collateral can be more challenging because a lender can not pre-file its mortgage or deed of trust prior to closing and funding. But title insurance can reduce or eliminate the risk of intervening liens. If the lender has obtained title insurance on the real property collateral, the lender can rely on its title policy to ensure that it has the proper lien position. A title agent will perform a date down search immediately before recording the lender’s lien instrument to confirm that no liens were filed of record since the date of the title commitment. The title agent will then issue a title policy which insures the lender that it has the anticipated lien position.
If the lender’s credit approval documentation and SBA Authorization do not require title insurance, the lender may choose to obtain a title search (sometimes referred to as an “Owner and Encumbrance search”) or other evidence of lien position instead (depending on the requirements of the Authorization). Lender should try to obtain a title search within 30 days prior to closing. If the search reveals that the lender will have the proper lien position, the lender can proceed to close the loan and record its mortgage or deed of trust. Once the lender’s lien instrument is recorded, the lender should order another title search on the property to confirm that no intervening liens were filed between the time of the search and the time of recording the lender’s lien instrument. If the search reveals intervening liens, the lender should act expeditiously to resolve the issue while it still has the borrower’s cooperation (rather than post-default when the borrower may not be cooperative) by obtaining a subordination from the intervening creditor, for example, or approving a post closing change memo if a different lien position is justified and approved by SBA, if applicable.
Whether the lender’s collateral includes personal property, real property or some other type of collateral, lenders should make sure they have the correct lien position on all collateral securing their loans to avoid a repair of the SBA guaranty.
For questions regarding guaranty purchase issues, contact the attorneys at Starfield & Smith at 215-542-7070 or visit our website at www.starfieldsmith.com.