Best Practices: SBA 7(a) Loans – When to Require Lien Searches on Sellers

Prudent SBA 7(a) lenders typically perform lien / UCC / judgment searches on sellers when there is a commercial real estate acquisition or a change in the ownership of a business.  Unless such searches are undertaken, lenders risk that liens or other seller obligations could attach to seller’s property and be assumed by the borrower.  This is turn could jeopardize the borrower’s ability to repay the loan; which could result in a default, leading to a denial of the SBA loan guaranty.  In this article and the two which follow, we will explore risks and cost considerations, while suggesting best practices.

Part 1: Lien Searches against Sellers of Real Estate

For commercial real estate (“CRE”) acquisitions financed by SBA 7(a) loans, SBA will require lenders to obtain title insurance insuring the lender’s lien on the CRE.  Lenders will rely on the title agent to perform all lien searches that would disclose any liens that would result in a “cloud on title” or an unacceptable exception to the lender’s loan policy of title insurance. The title agent will search the name of the selling owner of the real property for matters of record that indicate a lienholder that must be paid or otherwise resolved at closing. Types of liens that may be found by the title agent in the title search include:

• A mortgage, deed of trust, or security deed (all known as security instruments). These indicate that a secured lender must be paid at or prior to closing in exchange for release of the lender’s security instrument.
• Tax liens may be filed by any local, state or federal regulatory agency. Tax liens may arise from unpaid state-level employment taxes, unpaid federal or state income taxes, or unpaid real property tax assessments at the local level, among other things.
• Condominium or property association liens (or homeowner association liens, in the case of investment real estate), which result from failure to pay dues or assessments.
• A judgment lien, which attaches to real property when an individual or an entity files a lawsuit against an owner as a defendant and is awarded monetary damages in a court of law.
• A financing statement (“UCC F.S.”) may be filed as a “fixture filing” in the county real estate records indicating that a lender has a lien on “fixtures attaching to real estate,” owned by the owner of the real estate. These are a type of lien similar to mortgages and other security instruments.

All of these liens constitute impermissible exceptions on the policy of title insurance and must be paid or otherwise satisfied at or prior to closing by the Seller, who generally has an obligation to provide “good and marketable title.”  If the real estate meant to secure the new 7(a) loan is transferred, sold, refinanced, gifted, or otherwise conveyed without the lien being satisfied, the lien remains with the property and will obtain priority over the new lender’s 7(a) security interest in the real estate, in violation of prudent lending and the SBA’s SOP requirements.

Because the title agent performs the function of searching liens against the seller/owner of real estate, and because the title insurance commitment will disclose standard and non-standard exceptions (such as seller liens), Lender need only ensure that the loan policy of title insurance is going to be “clean” after closing, and the lender will be protected against liens that otherwise might affect a seller (and by extension the secured real estate) by virtue of the title insurance.  Lenders should carefully review the title commitment as well as the title policy pro forma to ensure that all liens will be cleared at or prior to closing of the acquisition.

In contrast, similar insurance is not generally available on a 7(a) business acquisition or change of ownership.  Parts 2 and 3 of this series of articles will explore the nuances of lien issues affecting sellers in the context of these transactions.

For more information, contact the attorneys at Starfield & Smith, PC at 215.542.7070.