SBA lending offers a powerful tool for financial institutions to expand their portfolios while mitigating risk through the government guaranty. However, that guaranty isn’t automatic. It’s conditional based on strict adherence to the Small Business Administration’s complex regulatory framework. 

Failure to maintain compliance can lead to repairs or a full denial of liability, turning a profitable asset into a significant loss. Specialized legal counsel serves as the primary safeguard against these risks. By integrating legal review into every stage of the loan lifecycle, lenders ensure that their processes meet federal standards and that their guarantees remain intact.

Navigating the Regulatory Maze

The backbone of SBA compliance is the Standard Operating Procedure (SOP). These massive documents dictate everything from borrower eligibility to liquidation protocols. They’re also living documents. The SBA frequently issues notices, procedural guides, and policy updates that can alter a rule overnight.

An internal lending team often lacks the bandwidth to monitor every regulatory shift while simultaneously processing new applications. This is where an attorney becomes essential.

Legal counsel functions as a real time regulatory filter. They interpret how new rules apply to current pipelines and existing portfolios. This proactive monitoring prevents lenders from using outdated forms or applying superseded underwriting criteria.

Ensuring Borrower Eligibility

The most common reason for an early denial of liability involves eligibility errors. If the borrower doesn’t qualify for the program, the loan is ineligible for the guaranty from day one. Attorneys assist lenders by conducting deep dive investigations into complex eligibility questions.

Eligible SBA loan applicants must be active operating businesses, organized for profit, located in the United States, and small as measured by SBA size standards.  Common eligibility issues include:

• Affiliation: Determining size standards requires analyzing all affiliates. Attorneys map out ownership structures to ensure the borrower is truly “small” by SBA definition.
• Character Issues: Legal teams review background checks and Form 912 issues to determine if a borrower’s past legal history disqualifies them.
• Use of Proceeds: Attorneys verify that loan funds aren’t being used for prohibited purposes, such as paying off ineligible debt or lending to a passive business.
• Originating a loan to an ineligible business type as denoted in 13 CFR 120.110.

Precision in Loan Documentation

Once a loan is approved, the documentation phase begins. This is the stage where most technical errors occur. The SBA requires specific language in security instruments to ensure the government’s lien position is valid.

Using standard commercial loan documents is often insufficient. An attorney ensures that the Note, Mortgages, Deeds of Trust, Security Agreement, and Guarantees align perfectly with the SBA Terms and Conditions.

Critical Documentation Tasks:

1. Terms and Conditions Review: Counsel reviews the SBA Terms and Conditions to make sure all terms match the credit memo and that the lender can actually meet all of the closing conditions.
2. Title Review: For commercial real estate, attorneys analyze title commitments to ensure there are no unauthorized liens that would jeopardize the SBA’s required lien position.
3. Lease Review: Attorneys review landlord waivers and lease terms to ensure the lender has access to collateral in the event of default.
4. Equity Injection Verification: Lawyers ensure that the source of the equity injection is documented exactly as required by the SOP, proving the funds aren’t borrowed.

The Role of an Attorney in Closing

Closing an SBA loan is a high pressure event. There are often dozens of checklist items that must be satisfied before funds can be released. An attorney for SBA lenders acts as the gatekeeper during this process. They coordinate with the borrower, third party vendors, and the title company to assemble the final package.

This coordination reduces the administrative burden on the lender’s closing department. It also creates a layer of accountability. If a document is missing or signed incorrectly, the attorney catches it before the loan funds. This immediate quality control is far more cost effective than trying to fix a file years later after a default or during an audit.

• Final Package Assembly: The attorney manages the collection of all signed documents required by the SBA Terms and Conditions.
• Settlement Statement Review: They verify that the settlement statement and disbursement sheet accurately reflect the loan proceeds, fees, and equity injection.

Risk Mitigation Strategies

The following table illustrates common compliance risks and how legal counsel provides a solution to mitigate them.

Compliance Risk	The Potential Consequence	How Legal Counsel Assists
Lien Priority Failure	The SBA repairs or denies the guaranty because collateral wasn’t secured.	Counsel performs thorough UCC and title searches to clear prior liens before closing.
Prohibited Fees	The lender must refund fees and face a regulatory penalty.	Counsel reviews the diligence documents and settlement sheet (Forms 1050 and 159) to ensure all charges are allowable.
Change of Ownership	Denial if the business valuation or bill of sale is flawed or if the transaction is structured in an ineligible manner	Counsel reviews comprehensive purchase agreements that comply with SBA business acquisition rules.
Environmental Issues	Liability for cleanup costs; loss of guaranty.	Counsel reviews Phase I reports to ensure compliance with SBA environmental policies.
Life Insurance	Repair of the guaranty if the policy isn’t properly assigned.	Counsel ensures the collateral assignment is properly recorded and acknowledged by the insurer.

Liquidation and Purchase Demand

Compliance doesn’t end when the loan closes. If a loan defaults, the lender must follow a rigid set of procedures to request the guaranty purchase from the SBA. This is known as the “10 Tab” or “Universal Purchase” package (“UPP”).

Submitting a purchase demand is an audit in itself. The SBA reviews the file to find reasons to deny payment. Attorneys assist lenders by assembling this package and framing the narrative.

The Liquidation Support Process:

1. Demand Letters: Counsel drafts legally compliant demand letters to obligors.
2. Litigation Management: If the lender must sue for a deficiency or foreclose, attorneys manage the litigation in compliance with federal timelines.
3. Offer in Compromise: Attorneys help negotiate and document settlements with obligors, ensuring SBA approval is obtained when necessary.
4. Package Assembly: Legal teams review the entire loan file to identify gaps. If a document is missing, they work to cure the deficiency before the SBA sees the file.

Developing Internal Policies

Beyond individual transactions, attorneys help lenders build robust internal operations. A strong lending policy is the first line of defense against non compliance.

Attorneys work with bank management to draft internal lending policies that mirror SBA requirements. This ensures that the lender’s business development officers and underwriters are working from a playbook that’s already compliant.

Training is another critical component. Frequent training sessions led by counsel keep the lending team sharp on the latest SOP changes. This culture of education reduces the likelihood of human error during the origination process.

• Policy Audits: Counsel periodically reviews the lender’s written lending procedures against the current SOP to ensure alignment.
• Team Training: Attorneys lead workshops focused on common mistakes and updated eligibility requirements.

Empirical Data on Compliance Failures

Data from SBA oversight reviews consistently highlights the cost of poor documentation. Historical reports indicate that a significant percentage of recommended repairs and denials stem from lien perfection issues and unauthorized use of proceeds.

For example, failure to properly secure a lien on business assets is a leading cause for repair. This essentially means the SBA deducts the value of the lost collateral from the guaranty payment. If the collateral was worth the entire loan amount, the guaranty is effectively zero. Legal oversight during the closing process is the direct antidote to these statistical trends.

Q&A: Common Compliance Questions

Can we use our standard bank loan documents for SBA 7(a) loans?

While you can use some standard forms, the SBA requires specific federal language and forms (like the Unconditional Guarantee) that supersede state specific documents. Relying solely on standard bank docs often leads to compliance gaps regarding federal jurisdiction and collateral rights.

When should we involve legal counsel in a transaction?

The earlier, the better. Involving counsel at the term sheet or commitment letter stage allows them to spot eligibility issues before you spend time and money on underwriting. At a minimum, counsel should be engaged once the credit is approved to handle the closing checklist.

Do we need an attorney if we have a PLP (Preferred Lenders Program) status?

Yes. PLP status gives you authority to approve loans on behalf of the SBA, but it also places the entire burden of compliance on you. If you make a mistake, the SBA won’t catch it until the loan defaults. PLP lenders need legal counsel even more than standard lenders because the safety net of SBA prior review is removed.

Can legal fees be passed on to the borrower?

Yes. The SOP allows lenders to charge the borrower for reasonable legal costs associated with loan closing. This includes the preparation of loan documents and title review. This makes hiring outside counsel a budget neutral decision for the lender in many cases.

Protecting the Guaranty with Starfield & Smith

The complexity of the SBA 7(a) program requires a partner who understands the high stakes of federally guaranteed lending. Compliance isn’t just about checking boxes. It’s about protecting the asset that makes the program viable for your institution.

Starfield & Smith provides the specialized legal support lenders need to navigate the SBA landscape with confidence. From eligibility reviews and loan documentation to liquidation and guaranty purchase, their team is dedicated to preserving your government guaranty. They act as an extension of your lending department, providing the regulatory armor needed to lend boldly and safely.

Get in touch with Starfield & Smith today to discuss how their compliance services can strengthen your SBA lending operations.