Best Practices: Failure to Request 1112 Payments Could Jeopardize Your Guarantee

On July 28, 2020 SBA issued Procedural Notice 5000-20041 (“PN 20041”) which provides additional guidance to Lenders on implementation of Section 1112 of the CARES Act. Section 1112 provides a subsidy for 6 months’ worth of payments for every SBA 7(a) and 504 loan in its portfolio, as well as every new loan originated and fully disbursed on or before September 27, 2020. PN 20041 provides additional guidance to Lenders on the implementation of Section 1112 payments, as well as advising Lenders as to the potential consequences of failure to comply with this provision.

PN 20041 advises Lenders “that if they do not submit, as required, the Section 1112 monthly report for SBA to make the Section 1112 payments on behalf of a Borrower and, if the Borrower thereafter defaults on the 7(a) loan without having received the benefit of the Section 1112 payments, the Lender will be at risk of SBA denying liability on its guarantee in whole or in part. The Lender will be also referred to the Office of Credit Risk Management (OCRM) for failing to comply with the Notices.” Because failure to comply with the requirements can risk both a Lender’s loan guarantee as well as creating oversight and enforcement risk with OCRM, a clear understanding of which loans must be submitted for 1112 payments is critical for Lenders.

SBA Procedural Notice 5000-20020 (“PN 20020”) provides that any 7(a) or 504 loans in “regular servicing” status are eligible to receive Section 1112 payments. The notice goes on the define loans in “regular servicing” as loans which have been closed and fully disbursed and which are not, and should not have been transferred into liquidation status, including loans which are 120 days or more past due. Generally SOP 50 57 2 only requires a loan to be placed in liquidation status of the Note has been accelerated. (SOP 50 57 2, Chapter 14, Paragraph A.). Generally, Lenders should follow their policies and procedures to otherwise determine when a loan should be accelerated. SOP 50 57 provides some additional guidance on which loans “should” be transferred into liquidation status which may include, in addition to loans in payment default 120 days or more, loans to borrowers that are in bankruptcy, borrowers that have closed their businesses or ceased operations, and borrowers that are making loan payments from collateral liquidation rather than business operations. However, all of these scenarios speak to defaults rather than classifying a loan in liquidation status, so the guidance can be, at times, unclear.

Lenders may find factual scenarios where it is unclear whether a borrower is eligible to receive section 1112 payments (e.g.: a borrower in bankruptcy). In such cases, it would be prudent for the Lender to seek guidance from SBA as to whether Section 1112 payments should be sought, as it is likely that such determinations will require a fact-based analysis and will need to be made on a case by case basis. As PN 200041 makes clear, a Lender’s failure to request 1112 payments for a borrower that subsequently defaults can be the basis for a denial of the guarantee. Accordingly, when the facts presented make it unclear as to whether such payments should be requested, additional guidance must be sought.

For more information on Section 1112 payments under the CARES Act, contact Ethan at 267-470-1186 or esmith@starfieldsmith.com