Best Practices: SBA Form 1050 and Other Disbursement Considerations for SBA 7(a) Loans

One common reason for SBA to issue a repair or denial of the SBA guaranty is a Lender’s failure to properly disburse an SBA loan in accordance with the use of proceeds set forth in the SBA loan authorization (the “SBA Authorization”).  Therefore, it is imperative that Lenders exercise caution when closing and disbursing SBA loans and that Lenders obtain the proper documentation to show for what and to whom the loan proceeds are disbursed.

Typically, a title agent, escrow agent, lender’s attorney, borrower’s attorney or Lender will draft a closing statement to set forth all figures related to the transaction, including, as applicable, the purchase price, any pro-rations or adjustments for taxes, insurance, rents, Lender’s fees, title and closing costs, any debts being paid off or refinanced, and any invoices being paid in connection with the transaction.  But SBA also requires that Lenders prepare the SBA Form 1050 Settlement Sheet (the “1050”) for all 7(a) loans other than Express loans, Export Express loans and 7(a) Small Loans.  The 1050 shows what the loan proceeds were used for, who the loan proceeds were paid to, how much was disbursed to each individual or entity and whether any loan proceeds are being held back for future disbursement. The 1050 also sets forth the amount of Borrower’s equity injection and the source of the equity injection, an issue of paramount importance to SBA.  Finally, because the 1050 requires that both Lender and Borrower certify that the loan proceeds were disbursed in accordance with the use of proceeds set forth in the SBA Authorization, this means that false statements may result in fines, civil liability or even criminal prosecution.

In addition to having a 1050 signed by Borrower and Lender at the initial loan disbursement, SBA also requires that Lenders obtain documentation to show that the loan proceeds were disbursed in accordance with the SBA Authorization.  Evidence of such disbursements typically includes copies of checks and wire receipts from the disbursement agent and copies of any invoices or purchase orders that were paid at closing.  Disbursement evidence must be sufficient for SBA to determine the payee, the amount of payment, the date of payment and the purpose of the payment.  Lenders must make sure that the evidence of disbursements properly aligns with the transaction closing statement (if applicable), the 1050, the credit memo, and the use of proceeds categories set forth in the SBA Authorization.

SBA requires that all subsequent or future disbursements be documented in the same way.  Subsequent disbursements often include payments to vendors and contractors, and so Lenders should obtain a copy of the applicable invoices, purchase orders and contractor draw requests as well as copies of paid receipts, cancelled checks or wire transfer receipts or other documentation showing that the payments were made to the proper parties and in accordance with the SBA Authorization.  See SBA SOP 50 10 6, Part 2, Section B, Chapter F, Paragraph D.3 for additional guidance and examples of acceptable documentation.  Although Lenders are only required to have a 1050 prepared and executed at the time of initial disbursement, Lenders should attach similar evidence of compliance for all future disbursements as well. Lenders must submit the executed 1050 and supporting documentation to SBA upon request, or in the event of a default, with the Lender’s guaranty purchase package.

Although the loan proceeds must be disbursed in strict accordance with the use of proceeds set forth in the SBA Authorization, SBA understands that some figures, such as closing costs, cannot be finalized until the closing date.  Therefore, SBA permits Lenders to disburse loan funds to Borrower, as working capital only, funds not spent for the purposes listed in the use of proceeds section of the SBA Authorization, “as long as those funds do not exceed 20% of the specific purpose authorized or $50,000, whichever is less.”

Lenders must also ensure that no working capital funds are disbursed to an eligible passive company (“EPC”).  Even if the 1050 and transaction closing statement show working capital  being disbursed to the operating company, it is important to obtain a copy of the check or wire receipt for that payment to make sure it was paid properly to the operating company rather than to the EPC.  Title agents, escrow agents and other disbursement agents should be made aware of this regulation if there is an EPC involved in the transaction.

Lenders must be diligent in completing the 1050 and in collecting and reviewing evidence to show that loan proceeds were properly disbursed in accordance with the use of proceeds set forth in the SBA Authorization.  Anything less could put the Lender’s SBA guaranty in jeopardy.  For questions regarding the 1050 or disbursement of SBA loans, contact the attorneys at Starfield & Smith at 215-542-7070.