SBA Technical Issues

By Joseph A. Ernst, Esq.  

     Under SOP 50 10 5(D), one of the permissible uses of loan proceeds is for the construction of new buildings and renovations to existing buildings. SOP 50 10 5(D), page 81. Furthermore, it is clear under the SOP 50 10 5(D) that twenty percent (20%) of a newly constructed building may be leased “permanently” to a third party tenant. SOP 50 10 5(D), page 137. However, effective as of October 1, 2011, the SOP 50 10 5(D) now contains an express prohibition against using loan proceeds to improve or renovate any part of the space that is leased to a third party tenant. In the context of an existing building, it typically is relatively easy to identify and segregate the costs of making improvements or renovations to space leased to a third party tenant and, hence, relatively easy to comply with the prohibition on using loan proceeds to improve or renovate the space leased to a third party tenant. In contrast, in the context of ground up construction, the distinction between using loan proceeds for the permissible use of new construction and using loan proceeds for the impermissible use of improving space leased to a third party tenant can be much more difficult to make, particularly if the Lender does not have a through understanding of what is being constructed and why.  

      In general, loan proceeds used to construct the building’s shell and the mechanical, electrical and other utility systems serving the entire newly constructed building are permissible under the SOP 50 10 5(D), even if part of the newly constructed building will be leased to a third party tenant. In contrast, loan proceeds used for improvements to a third party tenant’s space that are designed or intended for the third party tenant’s specific or unique use of its space are prohibited under the SOP 50 10 5(D).  In general, if the improvements are requested or needed by the third party tenant to operate its particular business operations in its space, then loan proceeds cannot be used for such improvements.  By way of an example, its is permissible under the SOP 50 10 5(D) to use loan proceeds to construct all of the structural floors for ground up construction. However, under the SOP 50 10 5(D), it would be impermissible to use loan proceeds to finance the tenant’s fit-out or even to reinforce the structural floor of the third party tenant’s space if the third party tenant’s use of its space dictated that its floor have a higher than normal load bearing capacity. Lenders should be mindful of who will directly benefit from the improvements and wgho requires the improvements when conducting this analysis.   

     Because there is a grey area in ground up construction between the permissible use of loan proceeds for new construction and the impermissible use of loan proceeds for third party tenant improvements, Lender’s need to be cognizant of this distinction between permissible and impermissible use of construction loan proceeds for certain types of improvements. In ground up construction, particularly in the case where a third party tenant is already lined up to lease part of the space, a careful and through review of the construction contract is warranted to ensure that loan proceeds will not be used for impermissible improvements to a third party tenant’s space. If the construction contract is unclear as to the scope of work and/or the improvements that are to be made to the third party tenant’s space, then the Lender must obtain clarification to ensure that the loan proceeds will be used for a permitted use. In addition, in many instances, the borrower/landlord would not be undertaking ground up construction without having first secured in some fashion the rental income from a third party tenant; consequently, there may be a letter of intent or lease with the third party tenant. If this is the case, the Lender should carefully scrutinize any such letter of intent or lease with the third party tenant to ascertain if improvements are being undertaken that are unique or specific to that particular third party tenant. Should this be the case, care must be taking when disbursing the construction loan proceeds to ensure that such tenant specific improvements are not funded with the loan proceeds. 

For more information regarding the prohibition on using loan proceeds for third party tenant improvements , please contact Joe at JErnst@StarfieldSmith.com  or (215) 542-7070.

By Ethan W. Smith, Esq.

     The life-cycle of an SBA loan can be divided into four main sections: 1) Underwriting/Origination; 2) Documentation/Closing; 3) Servicing; and 4) Liquidation. SBA lenders often find themselves focusing on one or two of these areas in their efforts to preserve and protect the SBA guaranty. However, SBA lenders should be mindful that the guaranty can be jeopardized in any one of the four stages of a loan.

     In the Underwriting/Origination phase of an SBA loan, mistakes can be made which imperil the guaranty regardless of subsequent actions taken by the lender. For instance, determinations regarding loan structure and eligibility, if incorrectly made, will often result in a recommendation for denial of the guaranty by the SBA National Guaranty Purchase Center (“NGPC”). Issues such as franchise eligibility, credit elsewhere, size standards and loan purpose must be correctly made or the guaranty will not be honored. Additionally, lenders’ credit decisions must be sound and well documented – early default loans will have their credit decisions reviewed by the agency. Although the SBA will not “second-guess” credit, the burden is on the lender to ensure that it has sufficiently documented its credit as a prudent lender.

     The Documentation/Closing phase of an SBA loan is an area that results in many repairs and denials of the SBA guaranty. Often, lenders will miss items in their due diligence such as intervening liens, missing tax transcripts, insufficient payoff letters, etc., that can give rise to repairs or denials of the SBA guaranty. SBA reports that the most frequent reason for a repair of the SBA guaranty is the failure to obtain the correct lien position on collateral as set forth in the Loan Authorization. Lenders’ failure to perform the correct searches and/or to resolve issues shown by the searches properly and thoroughly is often to blame. Additionally, failure to obtain a commitment from a creditor to release the lien being paid off also creates problems for lenders. Finally, lenders sometimes fail to properly document and/or perfect their liens which can also risk the guaranty.

     In the Servicing phase of the loan, lenders can endanger the guaranty by making servicing decisions that are imprudent or by failing to seek the approval of the agency when required. The SBA has made this process easier for lenders by issuing the Servicing and Liquidation Actions 7(a) Lender Matrix, which sets forth when SBA approval is required. However, it is important to remember that even if an action is delegated to the lender as a unilateral action, the lender must still document its file as to the reasoning and justification for each significant servicing action that it takes. Failure to do so can leave the SBA no choice but to recommend a repair if it cannot determine why the lender did what it did, and why it made sense.

      Finally, in the liquidation phase of the loan, lenders often make simple mistakes that have big consequences for the guaranty. For instance, lenders often fail to perform site visits within the mandated 60 days following a payment default. Although seemingly innocuous, the failure to perform the site visit in a timely manner shifts the burden to the lender to prove to the SBA that the failure to timely visit the site did not contribute to any loss. This can be a difficult, if not impossible, argument to make, especially if collateral is missing.

     SBA lenders need to be vigilant about guaranty protection throughout the entire life of an SBA loan. The four phases of an SBA loan, these “four pillars” of guaranty protection, are like the legs of a table – the loss of any one will likely make the “table” collapse and will expose the guaranty to repairs and denials.

For more information on preserving the SBA guaranty throughout all phases of an SBA loan, contact Ethan at ESmith@starfieldsmith.com or (215) 542-7070.

By: Jim Noone, SBA Lending – Relationship Manager

     The SBA introduced the 504 Refinance program in 2010 as part of the Jobs Act. It has taken more than 12 months for the benefits of this program to filter through to borrowers, however, the benefits are substantial for any business with a commercial mortgage.

     Let’s start with eligibility. In order to be eligible for this program, the business must have at least one loan that was originally used for the purchase of fixed assets. Conventional commercial mortgages are the most basic example, but, any debt used to previously acquire fixed assets meets this threshold.

     Once this has been established, we then look to the amount of the request. Under the 504 Refinance program, the borrower may request up to 90% funding based on the appraised value of the underlying fixed assets. The funds requested beyond the current outstanding balance of the mortgage can be used for “Eligible Business Expenses,” which is terminology for any working capital or capital expenditures of the business. These include salaries, utilities, improvements, and other loan repayments, including lines of credit.

     For example, a business currently has a commercial property with an estimated appraised value of $2 million and an outstanding commercial mortgage balance of $1.5 million. The owner may also have a Line of Credit of $200K that has, over the last two years, been difficult to pay-off and has become permanent working capital.

     Under the 504 Refinance Program, this borrower may request funding of $1.8 million (90% x $2 million). The use of funds would be $1.5 million to refinance the commercial mortgage, $200K to pay-off the Line of Credit, and $100K for general working capital. The structure of the request would be that either the existing mortgage lender or a new lender provides a 1^st Mortgage of $1 million and SBA provides a 2^nd Mortgage of $800K. The terms of the 1^st Mortgage are a negotiation between borrower and lender while the terms of the 2^nd Mortgage are typically a 20-year, fixed interest rate and 20 year amortization, without balloons. For borrowers that funded in March of 2012 in this program, the 20-year fixed rate on the SBA 2^nd Mortgage was 4.79%.    

     Creative ways to use this program for lenders include working with borrowers that are looking to expand without having demonstrated the period of stabilization required by the bank credit department. By utilizing the 504 refinance program in conjunction with the traditional 504 program, the lender can shift the higher LTV exposure in their existing collateral into two first mortgage positions on the existing and expansion collateral. Doing this typically retains the relationship with the borrower while minimizing credit exposure to 50% LTV loans.

If you are a borrower or lender seeking more information on how use of this program may accomplish your goals, please fill-out our contact form at Contact Seedcopa and we will follow-up with you quickly.

By Kimbery Rayer, Esq. 

     In 2010 the National Conference of Commissioners on Uniform State Laws approved proposed amendments to Article 9 of the Uniform Commercial Code (“2010 Amendments”). The 2010 Amendments are in the process of being adopted by each state with an effective date of July 1, 2013. Most of the 2010 Amendments are just clarifications to provisions of revised Article 9 that came into effect on July 1, 2001. Some of the proposed changes under the 2010 Amendments include: definition of an organization’s “public organic record” for purpose of determining a registered organization’s name; clarification on the “location” of a debtor and revisions to the filing requirements against trusts and estates. One of the 2010 Amendments is expected to have a considerable impact on how a secured party identifies an individual debtor on its financing statement.

     Current Article 9 simply requires that for individual debtors, a secured party use the “name of the debtor” on its financing statement. Due to nicknames, changing marital status and cultural differences, determining the correct “name of the debtor” has proven to be, at times, a challenge for secured parties.   Common law provides that a secured party should use the name an individual debtor is “commonly known by,” but courts have gone in different directions in determining what is sufficient evidence of a “commonly known as” name. For example, different courts have ruled that the name “Mike” is both sufficient and insufficient for identifying an individual debtor with the first name “Michael”. See In re Erwin, 50 UCC Rep Serv 2d 933, 2003 Bankr. LEXIS 692 (Bankr. D. Kan., June 17, 2003) and In re Larsen, 2010 WL 909138, 72, UCC Rep.2d 187 (Bankr. S.D. Iowa 2010).

     The proposed 2010 Amendments provide two alternative approaches to determining the individual debtor’s correct name for filing a financing statement. Alterative A provides that a secured party has properly perfected against an individual debtor “only if” the debtor’s name on the financing statement matches the debtor’s name as it appears on its state issued driver’s license (or state issued identification card).   If the individual debtor does not have a driver’s license (or ID card), then the secured party should use the individual’s first name and surname.

     Alternative B is commonly referred to as the “safe harbor” alternative. The provision allows for filing against the “name of the debtor” as provided under current Article 9, but provides a safe harbor for using the name designated on a state issued driver’s licenses or state ID card.

     While the requirement to use the debtor’s driver’s license in Alternative A provides some uniformity to filings and search requirements for secured parties, it has also raised some concern regarding what will happen when a debtor’s driver’s license expires? For example, does a financing statement filed using an individual’s driver’s license become ineffective if the debtor changes its name when he or she renews his or her license? Is the secured party obligated to obtain an updated driver’s license during the life of the loan?   However, if a state has adopted the safe harbor alternative, the secured party will continue to have the burden of searching the debtor’s name under a variety of “commonly known as” names and not just rely on the debtor’s driver’s license. Finally, each state’s option to adopt either Alternative A or B, or to adopt their own modified version of Alternative A or B, will require secured parties to research each state’s individual debtor name requirements when searching and filing against individual debtors, instead of relying on a uniform search criteria in all states.

     The changes proposed under the 2010 Amendments for the most part will not create significant changes for Lenders, but its in Lenders’ best interest to familiarize themselves with these amendments now so that they can determine what changes, if any, may impact their closing and servicing practices and adopt policies to address those changes before the July 1, 2013 effective date.  

For any questions about the 2010 Amendment or Article 9, please contact Kim at krayer@starfieldsmith.com or (215) 542-7070.