Published in NAGGL News Flash on June 7, 2019.
The goal of all SBA lenders is to have the SBA honor every loan guaranty. The keys to reaching that goal are exercising prudent lending and commercially reasonable practices; treating 7(a) loans with the same (or greater) care as you give unguaranteed commercial loans; complying fully with SBA program requirements; having staff engage in regular training; asking questions when unsure; and documenting decisions as events occur. Excellent communication within and outside the institution; a devotion to program integrity; supportive teamwork across bank departments; and maintenance of up-to-date policies and procedures also are key components for a compliant and efficient lending program.
While the SBA wants to honor every guaranty purchase request, it may not do so unless lenders originate, close, service and liquidate loans in accordance with Program Requirements and prudent lending practices. In fact, when the SBA determines that a lender’s acts or omissions are so serious that they warrant non-payment of the guaranty, a full denial of liability is recommended by the SBA purchase office. Recommended denials occur most often when a loan contains material deficiencies or losses, or when there are eligibility issues. The latter may include making loans to large businesses or businesses engaged in illegal activities, or it may include lender misconduct material to the soundness and integrity of the 7(a) loan program.
In contrast, a repair is an agreement between SBA and the lender for a specific dollar amount to be deducted from the purchase request and is designed to compensate SBA for a loss caused by the lender. According to the National Guaranty Purchase Center (NGPC – or, Herndon), no area causes more repairs to the guaranty than intervening liens. Fortunately, intervening liens can often be prevented by taking some basic steps. Set forth below are practices you may wish to consider when trying to secure real estate and personal property collateral.
Lenders know to take a first lien on commercial real estate being acquired and, to protect their lien, they will obtain title insurance. However, when their loans are under collateralized and they are taking residential real estate or investment property as collateral, they often run property searches rather than obtaining title insurance. While practices vary depending upon locality, as a general rule, when substantial equity exists in this secondary collateral, lenders should consider protecting their liens with title insurance. Searches may contain mistakes and omissions and will not account for all potential liens against real estate (such as real estate taxes). Accordingly, when substantial equity exists in collateral on which the lender will be taking a junior lien position, lenders should consider obtaining title insurance, the amount of which should generally be commensurate with the amount of equity in the property.
When a lender requires a certain lien position on its personal property collateral, it should carefully review its credit memo and Loan Authorization to make sure they are consistent. Next, lenders should strongly consider obtaining the borrower’s written approval – either through its commitment letter or later in the loan approval process – to “pre-file” its UCC-1 financing statement. To “pre-file” means to file the UCC-1 prior to loan closing and prior to having the security agreement signed. This is permissible under the Uniform Commercial Code. With the borrower’s approval in hand, you should file the UCC-1 and then run the search to reflect all outstanding liens.
If your UCC-1 is in the same lien position as anticipated (consistent with the bank’s credit memo and Loan Authorization), then the lender’s security interest in business assets cannot be primed or superseded. However, if the results are inconsistent with the loan requirements, then the lender must consider resolving intervening liens through termination or subordination, or modifying the credit memo and Loan Authorization to reflect the correct lien position, assuming that such modification will not adversely impact the credit decision, including the need to secure additional collateral. The lender may choose to pay off the intervening creditor, ask the creditor to subordinate its lien, or may proceed with the loan by modifying the credit memo and Loan Authorization if it can justify the lien position. Note that once a lender has pre-filed its UCC-1 and received verification of its filing, its UCC lien position cannot be primed by another creditor in most cases.
While exceptions exist for such items as purchase money security interests, or tax or mechanics’ liens, by taking the steps suggested, lenders can significantly minimize repairs to their loan portfolio in a prudent and cost efficient manner.
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