Best Practices: Construction Performance Bonds Under SOP 50 10 7

Since the issuance of SOP 50 10 7 there is an open question as to whether SBA Lenders must obtain evidence of performance and payment bonds for 7(a) construction loans.

For background, performance and payment bonds are issued between the construction contractor and the owner of the construction project. If a contractor fails to either complete the project or pay for the required labor and materials, the bond will cover the costs associated with the contractor’s failure to perform their obligations up to the amount stated on the bond. These bonds provide financial security to borrower and Lender but are often costly to contractors in the form of annual premiums to the bonding companies, which costs are typically passed on to the borrower in the construction contract.

Under the Code of Federal Regulations (the “CFR”), for all 7(a) loans that finance construction, the borrower must provide evidence of a 100 percent payment and performance bond to the SBA Lender unless this requirement is waived by SBA. 13 C.F.R. § 120.200.  However, under the prior SOP 50 10 6, Lenders were granted a blanket waiver to this bonding requirement if either of the following conditions were met:

• The Lender retained a third-party construction management firm that provides reasonable and prudent construction monitoring and funds control for all disbursements; or
• The Lender monitors construction and controls disbursements though an existing internal construction management department that routinely manages construction for its similarly sized conventional loans

The new SOP 50 10 7 removed both the requirement for payment and performance bonds as well as the blanket waiver described above. However, the SBA requirement for payment and performance bonds still exists in the current CFR, which takes precedence over the current SOP. To further muddy the waters on this issue, the SBA indicated on the July 11^th Connect Call that SBA intended to add back the construction monitoring provisions with its Technical Updates, which may reinstate the blanket waiver for prudent construction monitoring. However, the Technical Updates have not been issued yet, and SBA has not indicated a timeline by when the Technical Updates might be issued.

At this time, it is unclear whether SBA intends to enforce the bonding requirement of the CFR given the conflict between the removal of the blanket waiver from the SOP and the anticipated updates to the SOP provided to Lenders through the SBA Connect Call.  In guaranty purchase or a compliance audit, will SBA enforce the bonding requirement for construction loans even if a Lender acted in accordance with the prior SOP by utilizing a construction monitoring firm for all disbursements? Given the lack of clarity on the SBA’s stance it is important for SBA Lender’s to tread carefully.  The safest approach is to submit for general processing 7(a) construction loans that do not have a bond.  At a minimum, SBA lenders should diligently document their decisions on construction bonding and carefully monitor advances on their 7(a) construction loans until SBA issues further guidance on the issue through either a procedural notice or a Technical Update to the SOP.

For questions regarding SBA’s construction bonding requirements or other recent updates to the SBA 7(a) loan program, please contact the attorneys at Starfield & Smith at 215-542-7070 or email us at info@starfieldsmith.com.