Best Practices: The Importance of Lien Release Language in Payoff Letters

Failure to obtain the proper lien position on collateral is one of the most common reasons for a repair of the SBA guaranty, but the good news is lenders can take steps to reduce the likelihood of intervening liens. While title insurance is often used to ensure a lender has the proper lien position on real property, there is no equivalent insurance policy for liens on personal property. One way lenders can ensure that they have the correct lien position on personal property is to pre-file a Uniform Commercial Code (“UCC”) financing statement after obtaining written consent of the debtor and to obtain a post-filing search which confirms the lender’s correct lien position. But sometimes a pre-closing UCC search reveals secured debt that will be paid off at closing, thereby preventing a lender from obtaining confirmation of their correct lien position in advance of closing. This often occurs when loan proceeds are being used to refinance a borrower’s business debt or when a UCC financing statement filed against a seller in a business acquisition is being paid off at closing out of sale proceeds.

In these situations, lenders must get written confirmation from the secured party of record (the “Secured Party”) that the Secured Party will release its security interest in the collateral set forth in the UCC financing statement and that the Secured Party will terminate its UCC financing statement (or even better, that Secured Party authorizes the lender to terminate the UCC financing statement) upon receipt of the proceeds being paid at closing. This is often addressed in a payoff letter, but lenders must read the payoff letter carefully to determine if the letter contains proper lien release language.

Some form payoff letters are silent with respect to lien release language or only contain general lien release language that states all collateral securing the loan being paid off will be released if such collateral does not secure another loan with the Secured Party. The problem with general language like this is that the lender relying on the payoff letter often does not know if the loan being paid off is cross collateralized with another debt. To resolve this issue, the Secured Party will sometimes agree to add language to the payoff letter to confirm which specific UCC financing statements – and other collateral – will be terminated upon receipt of payoff funds. It is often helpful for the lender to supply the Secured Party with a list of UCC financing statements that lender believes are securing the loan being paid off so that both lender and Secured Party can confirm they are in agreement. The Secured Party may also be willing to provide draft copies of the UCC-3 terminations which will be filed after receipt of the payoff funds.

Sometimes, if the Secured Party is not willing to modify their form payoff letter, the Secured Party may be willing to provide a different form of written communication outside of the payoff letter, such as an email, in which the Secured Party confirms the specific collateral to be released. It is important to note that a borrower’s, guarantor’s, or seller’s statements cannot substitute for written confirmation from the Secured Party as to what collateral will be released.

Once the loan closes and funds, lenders should obtain a post-closing UCC search to confirm that all UCC financing statements that were paid off at closing were actually terminated. If the search reveals that not all UCCs were terminated in accordance with the payoff letter or other written communication, lenders should follow up with the Secured Party to obtain copies of recorded UCC-3 terminations. It is much easier to obtain UCC-3 terminations post-closing when lender can provide Secured Party with a letter or email in which Secured Party previously agreed to release such collateral.

Although obtaining sufficient written lien release confirmation from a Secured Party can often take several attempts and requests to the Secured Party, such time and effort is worth it to avoid a post-closing intervening lien which could result in a repair of the SBA guaranty if it cannot be corrected. For questions regarding payoff letters or obtaining proper lien positions, contact the attorneys at Starfield & Smith at 215-542-7070 or email us at info@starfieldsmith.com.