Best Practices: Collateral Adequacy Analysis For 504 Loans Under SOP 50 10 8.1

Certified Development Companies (“CDCs”) have many responsibilities when analyzing real property collateral for a potential 504 loan, and the SBA has now added a new requirement to the collateral adequacy analysis for CDCs to consider.  It is important for Third Party and Interim Lenders, as well as CDCs, to understand this requirement to get 504 loans approved by the U.S. Small Business Administration (“SBA”) promptly.

CDCs must consider the impact that all covenants and restrictions recorded in title records have on the value and marketability of real property collateral, including:

a) Deed restrictions, covenants, easement provisions, reversionary interests, subordinations, leases and options and other provisions that restrict the use of the property for the benefit of a third party.

i) Please note that use restrictions which are intended to protect the health and safety of occupants may be acceptable. Examples of such use restrictions are deed restrictions based upon environmental concerns, including restrictions on residential use, use as a day care center for children or seniors, use as a school, or use as a hospital.

b) Engineering Controls that require the small business concern or subsequent owners to install costly devices or structures such as extraction wells or subsurface barrier walls before constructing a building, remodeling, or otherwise improving the property.

c) Environmental Indemnification provisions that run with the land. If any are found, they must be removed or waived as to the Federal Government, or the real property will not be eligible for a 504 loan.

Under SOP 50 10 8.1, CDCs must work with an SBA lawyer to determine if the real property collateral is subject to any non-environmental open-ended (indefinite) indemnification provisions. These provisions would require a subsequent owner of the real property, which could potentially include the SBA or SBA Lender following a default, to indemnify a third party. If such a provision is found in the documents of record, then:

a) The CDC must attempt to obtain a written waiver and release for the Federal Government/U.S. Small Business Administration from the beneficiary of the indemnification provision. The waiver and release would have to be recorded in the land title records prior to loan closing.

b) If the CDC cannot obtain such waiver, the CDC must submit a 327 action: (a) identifying the title provision, and (b) documenting its attempts at obtaining a recorded waiver, to the SLPC for resolution.

Finding the beneficiary of a non-environmental open-ended (indefinite) indemnification could take significant time and effort, so the sooner the documents of record are obtained and reviewed, the sooner any such provision can start to be addressed to maintain strict SBA compliance.

If a Third Party or Interim Lender obtains a title commitment that includes any open-ended (indefinite) indemnification provisions, they should relay that information to the CDCs as soon as possible to coordinate on next steps. Full disclosure and coordination will help prevent later surprises if a CDC faces challenges in obtaining the required waiver and release.

For more information regarding these SBA requirements, please contact the attorneys at Starfield & Smith, P.C. at info@starfieldsmith.com or (215) 542-7070.