Best Practices: The Importance of Certificates of Good Standing

Prior to the closing of an SBA loan, it is critical that lenders obtain appropriate documentation that the borrowing entity is in good standing. The best evidence to confirm active status and verify good standing is a Certificate of Good Standing (also sometimes known as Certificate of Existence) obtained through the Office of the Secretary of State in the jurisdiction where the borrowing entity is established. The SBA Loan Authorization requires this. The Certificate serves as evidence that the borrowing entity is registered with the State; it demonstrates that the entity is authorized to transact business; and, in some jurisdictions, an entity’s lack of good standing may impair a lender’s ability to secure its collateral.   

While each State monitors business entities for compliance with local requirements, during the loan application process, it is not uncommon for lenders to learn that a borrower’s good standing status has been revoked. Three common reasons for borrowers to lose their good standing status are: (1) failure to timely file annual reports; (2) failure to maintain a registered office within the jurisdiction; or (3) failure to pay fees or taxes owed to the State. It is important for lenders to be proactive and inquisitive with its customers in order understand what caused them to lose their good standing status since most of the reasons cited above are often rectifiable. 

The consequences for losing good standing status can have lasting effects on the borrower, which, depending on the jurisdiction, include but are not limited to: (1) a borrower’s ability to secure capital or obtain financing from banks or other lending institutions; (2) a borrower’s ability to file a civil complaint or bring a lawsuit; (3) tax liens that will encumber all assets of the borrower; (4) administrative dissolution or revocation of a borrower’s business status by the State; (5) additional fines or penalties imposed by the State; and (6) exposure of principals to personal liability during the time of noncompliance. The above list is by no means exhaustive and should be of concern to all lenders. Because these examples of non-compliance with state requirements may impair a borrower’s ability to operate its small business successfully, the failure to obtain a Certificate may create serious consequences for both the SBA and lender.  Even on Paycheck Protection Program (“PPP”) loans, an entity not in good standing may generate a “Dormant Business” Error Message / Hold Code 506.  

Accordingly, for SBA lenders in particular, the revocation of a borrower’s good standing certificate is particularly problematic.  Without a valid good standing certificate, a 7(a) lender which proceeds with the financing does so in direct violation of the Loan Authorization’s express requirements.  This may not only jeopardize the loan guaranty but it may also prevent a lender from enforcing its rights under the loan documents.  Accordingly, lenders should always review the Certificate of Good Standing carefully to ensure that the borrower is in fact in good standing and, if not, direct the borrower to take the steps necessary to rectify any issues so that a clean Certificate is in the lender’s file prior to the financing.   

For further assistance please contact the attorneys at Starfield & Smith, P.C. at 215-542-7070 or email us at info@starfieldsmith.com.