Best Practices: Insurance Requirement Changes for SBA 7(a) Loans

Hazard insurance requirements for SBA 7(a) loans were updated in SBA Procedural Notice No. 5000-846607, which went into effect on May 11, 2023.  The changes to Hazard insurance, along with changes to flood insurance requirements for SBA 7(a) loans are being updated under SOP 5010(7), which takes effect August 1, 2023.

Hazard insurance requirements on real property and personal property for SBA loans that are greater than $500,000.00 have not changed from the requirements in SOP 50 10 6.  SBA still requires hazard insurance on all assets pledged as collateral, including additional policies for those small businesses operating in a state that requires additional coverage such as wind, hail, earthquake, or other such special insurances.

Hazard insurance coverage must be in the amount of the full replacement cost, but if full replacement cost insurance is not available, coverage must be for the maximum insurable value.  Real estate hazard insurance must contain a Mortgagee clause (or substantial equivalent) and personal property hazard insurance must contain a Lender’s Loss Payable clause (or substantial equivalent), each in favor of the Lender which provides that any action or failure to act by the mortgagor or owner of the insured property will not invalidate the interest of the Lender. Finally, the policy or endorsements must provide for at least 10 days prior written notice to the Lender of policy cancellation.

For SBA loans of $500,000 or less, the SBA requires hazard insurance on real estate acquired, refinanced or improved with the proceeds of an SBA loan.  The hazard insurance requirement for Small 7(a) SBA loans must be in accordance with the Lender’s personal property hazard insurance policies for their similarly-sized non-SBA guaranteed commercial loans.

Flood insurance under the National Flood Insurance Program (the “NFIP”) or comparable private flood insurance that meets the requirements on page 77 of SOP 50 10 7 is now required “if any building (including mobile homes), machinery, or equipment acquired, installed, improved, constructed, or renovated with the proceeds of SBA financial assistance is located in a special flood hazard area.  The requirement applies also to any inventory (business loan program), fixtures or furnishings contained or to be contained in the building.”

There has been no change in the amount of insurance or other flood insurance coverage requirements under the new SOP.  The coverage must still be the lesser of an amount at least equal to the outstanding principal balance of the loan or the maximum limit of coverage made available under the National Flood Insurance Act of 1968, as amended (42 U.S.C. 4001 et seq.).

It must still contain a Mortgagee clause and/or Lender’s Loss Payable clause (or substantial equivalent) in favor of the Lender, which provides that any action or failure to act by the debtor or owner of the insured property will not invalidate the interest of the Lender. The policy or endorsements must still provide for at least 10 days prior written notice of policy cancellation to the Lender or 45 days prior written notice in the case of private flood insurance.

The big change in flood insurance is that the SBA no longer requires it on real property or personal property located in a building not being acquired, installed, improved, constructed, or renovated with loan proceeds.  No longer will a lender have to provide written justification for not requiring such flood insurance, as was required under SOP 50 10 6.

Also changed are the requirements for proof of flood insurance for a condominium or cooperative unit that is located in a special flood hazard area.  In the past, the lender was required to obtain proof of insurance from both the unit owner for the inside of the unit, and the condominium/cooperative organization for the outside of the unit.  Under SOP 50 10 7, lenders would only need to obtain proof from the unit owner for the inside of the unit.

Lenders should remember that SBA insurance requirements are just minimum requirements and lenders should be consistent with their insurance policies for non-SBA commercial loans.  Further, lenders are also expected to maintain a prudent lending standard, which SBA may consider if a hazard or flood occurs and destroys collateral where no insurance was required by the lender.

SBA has announced there will be Technical Updates to SOP 5010(7), but they have not been issued at the time this Article was written.

For further assistance please contact the attorneys at Starfield & Smith, P.C. at 215-542-7070 or email us at info@starfieldsmith.com.