Best Practices: Leasing Requirements

During the 7(a) Connect Quarterly Update call on July 9, 2024 the Office of Credit Risk Management (“OCRM”) demonstrated an example of how it reviews a specific loan program requirement when reviewing loan files.  The example used was use of proceeds, occupancy and leasing requirements, and responsibilities when the borrower is leasing space.

In relation to leasing requirements, OCRM first determines which provisions of SOP 50 10 7.1 are applicable since some lease responsibility language in SOP 50 10 7.1 was changed by SBA Procedural Notice 5000-852522.  If the loan originated between November 15, 2023 and December 5, 2023, then the following language in SOP 50 10 7.1 applies to the loan:

1. Responsibilities When the Borrower is Leasing Space:

a. The lease term, including renewal options exercisable only by the Borrower, must equal or exceed the term of the loan.

b. An assignment of lease and Landlord’s waiver should be obtained either when a substantial portion of the loan proceeds are to be used for leasehold improvements or a substantial portion of the collateral consists of leasehold improvements, fixtures, machinery, or equipment that is attached to leased real estate.

If the loan originated after December 5, 2023, then OCRM would be reviewing the loan file to ensure compliance with the following:

1. Responsibilities When the Borrower is Leasing Space:

a. When the Borrower is operating in leased space and when a substantial portion of the loan proceeds will be used for leasehold improvements or a substantial portion of the collateral consists of leasehold improvements, fixtures, machinery, or equipment that is attached to leased real estate:

i. The SBA Lender must obtain a copy of the written lease between the Borrower and the landlord. For 7(a) loans, the lease term, including renewal options exercisable only by the Borrower, should equal or exceed the term of the loan. For 504 loans, the lease term must equal or exceed the term of the loan. An assignment of lease and Landlord’s waiver should be obtained.

ii. If the SBA Lender is unable to obtain the assignment of lease or landlord’s waiver, for both 7(a) and 504 loans, the lease term, including renewal options exercisable only by the Borrower, must equal or exceed the term of the loan. Additionally, the SBA Lender must document its file with the attempt to obtain the assignment and the landlord’s waiver and the reason(s) for not providing it.”

After confirming the applicable lease rules that apply to the loan, the Lender should confirm that the lease:  (i) lists the borrower as the tenant (not an owner or affiliate of the borrower), (ii) identifies the landlord and leased location address,  (iii) is signed by both parties, (iv) the term of the lease matches the term of the loan (consider including extra time as a buffer) and  (v) renewals are only exercisable by the borrower.  Documentation that a lender could include in its file to show it attempted to obtain the assignment and landlord’s waiver are emails between lender and landlord and redlines of the documents showing negotiations with landlord.  Additionally, any State law which demonstrates lender’s priority in any collateral located at the property would be of great benefit in a lender’s file.

Lenders should keep in mind that when OCRM is reviewing loan files, it is not only looking at each file individually, but also reviewing compliance as a whole by the lender.  If it discovers non-compliance throughout many of a lender’s loan files, without satisfactory explanation and/or documentation contained in the relevant files, then a lender’s ability to continue to provide 7(a) loans could be in jeopardy.  Therefore, lenders should develop policies and procedures to insure consistent compliance of SBA regulations in their SBA lending practice.  For example, an applicant checklist should include a request for a copy of the lease with details of the SBA requirements.  In determining whether to move forward with a loan where compliance with the SBA leasehold requirements can’t be met, the lender should describe in its credit memorandum the potential impact to the SBA Guaranty and how lender is mitigating the risks.  Finally, lenders should routinely review leases during servicing actions to address any shortfalls in its compliance with the SBA leasehold requirements.

For questions regarding leasing requirements and other common OCRM compliance review issues, contact the attorneys at Starfield & Smith at 215-542-7070 or email us at info@starfieldsmith.com