When SBA lenders encounter an applicant that is a trust or is owned by a trust, knowledge of SBA’s trust requirements is essential. Understanding SBA guidance not only helps lenders to determine whether or not a trust is eligible, but is also helps lenders to evaluate whether or not the trust must guaranty the loan, and how lenders should document the loan properly. Here are some of the basics to keep in mind.
The first step is to gather the trust documents. This is typically the Trust Agreement and/or a Certificate of Trust. Know your state’s legal requirements because state laws vary. For instance, in many jurisdictions, if a certification or memorandum of trust contains crucial information, then lenders must accept this in lieu of the entire trust instrument.
In either case, when you review any purported trust or Certificate/Memorandum of Trust, you should be able to clearly establish the existence of the trust, identify the trustor and trustee, state the powers of the trustee, how the assets of the trust are to be titled, and identify the beneficiaries of the trust. In some jurisdictions, a trust may be registered with the state but, in most cases, trusts are not recorded or registered; they are merely created consistent with state law. Whether a trust is revocable or irrevocable does not usually impact its ability to be a borrower or a guarantor under an SBA Loan, although clarity around the issue is important to understand and must often be disclosed to SBA.
When an SBA lender comes across a small business applicant whose ownership interests or assets are owned by a trust, the first question often asked is whether the trust or trustee needs to be a borrower or a guarantor of the loan? The simple answer is that if the trust benefits directly from the loan, then it should be a borrower. For example, if SBA loan proceeds are used to purchase real estate to be held by the trust and leased to an operating company, then the trust should be treated as an Eligible Passive Company (“EPC”) borrower. If a trust owns at least 20% of the outstanding equity interest in an SBA applicant, then it must provide an SBA guaranty.
However, certain types of employee benefit trusts (i.e. 401(k) plans or Employee Stock Ownership Plans, aka ESOPs) may be prohibited from furnishing a guaranty under federal tax law (if they want to retain their tax status). The SOP 50 10 (6) makes an exception to the rule that 20% or more owners of a small business applicant must guaranty the SBA loan for 401(k) plans and ESOPs who own the applicant. However, the exception does not exist for applicants that are EPCs. Remember, if the 401(k) Plan or ESOP owns the EPC, the EPC is ineligible for SBA financing.
There are a number of provisions in SOP 50 10 (6) which address trust documentation requirements. As a general rule, a trust does not need to meet the criteria as “small” under SBA regulations in order to qualify for SBA financing. Instead, the SOP states that in order to determine whether or not a trust is eligible for SBA financing, a lender must determine the eligibility status of the trustor (the party that created the trust). A tricky nuance is that all donors to the trust are deemed to be trustors for the purpose of determining the eligibility of the trust. However, beneficiaries of the trust are not considered for eligibility purposes, but may be required to provide a guaranty if they can exercise any control over the actions of the trust. It is a complex area but we find it helpful to remember that SBA’s general rule is that, except when a sole proprietor is the borrower, SBA expects lenders to find a guarantor under its 7(a) program requirements.
In your loan documentation, per the 2018 SBA Loan Authorization Boilerplate, the trustee must certify to the SBA lender that the trustee: (i) is authorized to act on behalf of the trust, (ii) has the authority to borrower funds, (iii) can pledge assets, (iv) can lease the property to the OC, if applicable, and (v) will not revoke or substantially amend the trust without the consent of the SBA lender during the term of the loan. The SOP also requires that the trustee must provide accurate, pertinent language from the trust agreement confirming the above and provide a true and complete list of all trustors and donors to the trust.
Whether trust assets are held in the name of the trust or in the name of the trustee, these assets should be identified in the trust instrument. This is important to confirm. If trust assets are titled in the name of the trustee on behalf of the trust, the loan documents may need to identify the trustee as the grantor of the lien against the collateral. Accordingly, lien instruments, such as mortgages, deeds of trust, security agreements, financing statements and pledge agreements, may need to be filed or recorded against the individual trustee(s) (not just the trust). Pay particular attention if the trustee’s primary residence is different than the state of organization for the trust, which may change the jurisdiction for recording of a financing statement against the trustee and trust assets.
By keeping these guidelines in mind, lenders can help to ensure that their SBA loans involving trusts are properly secured and are compliant with the applicable SBA program requirements. For more information regarding SBA loans involving Trusts, please contact Kim at firstname.lastname@example.org or 267-470-1208.