Best Practices: SBA 7(a) Loans – When to Require Lien Searches on Sellers – Part 2

This article is the second part in a series of articles on lien searches on sellers. For background, please see Part 1 in this series, Best Practices: SBA 7(a) Loans – When to Require Lien Searches on Sellers | Starfield & Smith Attorneys at Law (starfieldsmith.com). This article will examine the nuances in performing lien searches in asset purchase transactions, other than Uniform Commercial Code searches.  The final article in this series will examine lien searches for seller of stock in a corporation or interests in limited liability companies.

An asset purchase occurs when an acquirer buys only those personal property assets specifically stated in the purchase agreement.  Most sellers pay any liabilities at the time of closing with sales proceeds.  Therefore, it is imperative to account for all potential encumbrances against a seller and its assets prior to closing to ensure that title to such assets are free and clear of such encumbrances. If such encumbrances are not satisfied, the buyer may not only inadvertently assume existing seller obligations, which may impact buyer’s ability to repay the 7(a) loan, but the buyer will not acquire clear title to the assets, and the lender’s lien position will end up inferior to that of another creditor, in violation of the 7(a) loan authorization and the rules of the SOP.

Following is a discussion of certain types of searches, in addition to UCC searches, that may be prudent, depending on the nature of the asset purchase transaction.  Lenders should consult with competent closing counsel to ensure that the searches performed on sellers are reasonably obtained on all required parties in the appropriate jurisdictions.

Assets in Individual Names

With smaller businesses, individual owners of the business often acquire assets in their individual names, such as the individual who initially acquires a truck in her name but later begins to use the truck for company purposes, and never transfers the title to the corporate name.  In those cases, best practices dictate that not only should the Seller’s corporate name be searched, but any member or owner that may have acquired assets used in the business in their individual names be searched as well. Lenders should request and review title to vehicles and other equipment as soon as practical, in order to know whether title is held in the name of the actual seller listed in the purchase agreement.

Tax Liens

Care must be taken with tax liens, such as federal or state tax liens, that attach to personal property of a Seller.  Lenders should obtain searches covering any federal or state tax liens on all applicable seller parties.  These types of liens will generally attach to all existing property of a Seller after proper notice and a filing of the lien, and will also attach to all property acquired after the creation of the lien.

Seller should be required to provide a certificate of “tax lien clearance” or “good standing” from the applicable state taxing authority such as the Department of Revenue.  Take note that this requirement is separate from an entity’s “certificate of good standing,” which is provided by the Secretary of State of the applicable jurisdiction, and pertains only to legal status and entity formation.

Judgment Liens versus Docket Searches; Bankruptcy Searches

Lenders generally know to request a “judgment lien” search and bankruptcy search with regard to any seller of assets, which will disclose any liens against seller resulting from a lawsuit and any active bankruptcy filings (respectively). But what about liens that have not yet been reduced to a judgment? Seller typically must disclose all ongoing litigation, but in some cases they do not, whether intentionally or because they think that such suits are immaterial.

In the same way that lenders obtain a bankruptcy and judgment lien search on a seller, prudent lenders should request and obtain an active docket search for ongoing civil litigation against any seller in the Seller’s home jurisdiction and/or the county where the Seller operates.  This will disclose any active litigation against seller that may later result in a judgment that could attach to Seller’s assets.  Since the sale of any assets during ongoing litigation without court approval may be considered a fraudulent transfer by Seller, if a money judgment is later obtained, then the judgment lien may attach by operation of law to the transferred assets.

Final Notes

Any unusual results, or information indicating that there may be unusual circumstances affecting title to personal property should result in a credit flag and additional questions for the Seller. Lenders are encouraged to consult with legal counsel for guidance through any asset purchase transaction, as early as practical.

For more information, contact the attorneys at Starfield & Smith, PC at info@starfieldsmith.com or 215.542.7070.