An updated SBA Form 1086 – Secondary Participation Guaranty Agreement, which is used to sell the guaranteed portion of an SBA 7(a) loan in the secondary market, was issued effective August 1, 2024. SBA has stated that its intention is to streamline and update the Agreement to reflect recent SBA policy changes, and to further balance the interests of the applicant, lender, and investors in the Agreement.
The data tables in the new Agreement were reorganized so there is no duplication of data points. In addition, some of the data fields are auto-populated from data in E-Tran, but any field can be overwritten by the lender. Changes were also made to address the different types of prepayments.
The most substantive change is the addition of the following Lender representation in Article 2.1(j), which states:
Lender represents that as of the Warranty Date, which is the date of settlement of this transaction as determined by the SBA and FTA, neither Lender nor any of its directors, officers, employees, or agents has or should have through the exercise of reasonable diligence, any actual or constructive knowledge of any information indicating the likelihood of prepayment or accelerated principal paydown of the Loan by Borrower by refinancing or otherwise. In addition, if any proceeds from this loan are to be utilized to pay down an existing SBA guaranteed loan, Lender has explored all possible means, including working with the existing lender, investors, and the SBA to accomplish the Borrower needs without triggering such paydown or prepayment of Loan. Further, Lender affirms it has acted prudently and verified with Borrower that Borrower has no intention to either pay down or prepay Loan.
The representation requires that the lender has conducted significant due diligence into the intention of the Borrower regarding refinancing its SBA loan(s). It applies to lender, its directors, officers, employees, or agents. Agents may mean not only lender service providers or packagers, but referral sources. Further, the exercise of reasonable due diligence is presumed to cover not only “actual knowledge,” but “constructive knowledge of any information indicating the likelihood of prepayment or accelerated principal paydown of the Loan…” This level of inquiry into the commercial borrower’s “intentions” with respect to the loan is exceptional for commercial lending. In fact, it would not be uncommon for commercial borrowers to have as part of their long-term strategic plan an intention to refinance debt prior to its maturity date. Therefore, requiring the lenders to represent that the borrower has no intention to refinance debt seems to open the lender to a new level of liability and challenge to its lending practice.
The second part of the Section 2.1(j) requires the Lender to represent that it has “explored all possible means, including working with the existing lender, investor and the SBA to accomplish what the Borrower needs without triggering paydown or prepayment of the Loan.” This standard is beyond the requirement in SOP 50 10 7.1, which says any new loan that refinances an existing SBA 7(a) loan must meet the 10% improvement to installment payment amount and pay any applicable subsidy recoupment fees.
While a higher standard may be appropriate for a loan sold on the secondary market in exchange for the premium, the standards set forth in the new SBA Form 1086 seem beyond standard commercial due diligence. While SBA’s intention is to preserve the integrity of the secondary market, it may unintentionally create more risk for SBA lenders and put a chill on lending to small businesses. For example, if certain lenders may not issue a commitment to any applicant that answers in the affirmative that it may refinance its SBA loan prior to its maturity date, then the applicant has fewer financing options. If during seller negotiations, it is proposed that the borrower may need to refinance its SBA loan in a few years to take out the seller note, that constructive notice may force the lender to withdraw its commitment. Even with sufficient conditions set forth in its commitment letter, a lender may face a lender liability claim if it withdraws its commitment over constructive notice of a potential future refinancing of the SBA loan.
It’s also unclear how a new lender may require a borrower to work with its existing lender and investor to keep a loan in place that it is seeking to refinance. Further, for lenders who choose to ignore the 2.1(j) representation, the risk may be their ability to participate in the secondary market or possibly the 7(a) loan program.
SBA Lenders who rely on secondary market sales should consider adding a notice to their commitment letters regarding secondary market sales. They should also include conditions for closing that the SBA loan meets SBA requirements for closing, and that it also meets the standards for selling the loan on the secondary market.
For more information regarding SBA Form 1086 and secondary market sales requirements, please contact Kim Rayer at krayer@starfieldsmith.com.
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