2016 Wisconsin SBA Lenders Conference
May 19, 2016
SBA Loan Closing: Proper Documentation & Pitfalls
Today’s Presenter
• Nick Jellum, Anastasi Jellum P.A.
14985 60th Street North, Stillwater, MN 55082
Phone: 651‐439‐2951
E‐mail: Nick@AJ‐Law.com
The SBA Authorization
• The Authorization is SBA’s written agreement between the SBA and lender providing the terms and conditions under which SBA will guarantee a business loan (SOP 50 10 5 (H), pg. 183)
• The Authorization should guide your documentation
1
The SBA Authorization
• Make sure the Authorization is consistent with the lender’s credit/loan approval
–
–
–
–
–
Interest rate and adjustment period
Maturity
Required collateral
Required guarantors
Use of proceeds
The SBA Authorization
• Make sure the Authorization is consistent with SOP requirements
– Required borrowers (e.g., individuals must be co‐borrowers in certain change of ownership loans)
– Required guarantors (generally, any individual or entity that owns 20% or more)
– Maximum loan amounts
• The maximum loan amount can change depending on which SBA program is used (standard 7(a), 7(a) Small Loans, Express, etc.)
• Note that if affiliation exists, SBA’s loan maximums apply to all the affiliated businesses as if they were a single business
The SBA Authorization
• SOP requirements (cont.)
– Maturity dates:
• The loan term must be the shortest appropriate term based on the use of proceeds and the borrower’s ability to repay – SOP 50 10 5 (H), pg. 130
• Equipment loans should not exceed 10 years (or the useful life of the equipment). Real estate loans cannot exceed 25 years
– Interest rate:
• SBA loans may have a fixed or variable rate. SBA will periodically publish the maximum allowable fixed interest rate in the Federal Register
– Required collateral:
• Must have a 1st lien on any assets being financed
• If not fully collateralized, personal guarantors may be required to pledge personal assets, such as a lien against their homestead
2
The SBA Authorization
• SOP requirements (cont.)
– The SBA provides an “SBA Wizard” for assistance in preparing an Authorization. Other third‐party vendors also provide software that generate Authorizations. However, lenders should not purely rely on these tools, and must make an independent determination that the Authorization complies with SBA lending requirements
• Once the Authorization has been created properly, take care to ensure that the loan is closed in accordance with the Authorization.
– Review the Authorization carefully and often during the documentation and closing process
Drafting the SBA Note (Form 147)
• Ensure front page properly identifies Borrower, Lender, SBA Loan No., SBA Loan Name, and Loan Amount
– These items should match the Authorization exactly
• When you have an EPC/OC loan structure, if the EPC and OC are co‐borrowers, both should be identified in the “Borrower” box, and the OC should be included in the “Operating Company” Box
Drafting the SBA Note (Form 147)
• Note terms in page 2 of the Note must match exactly the Note terms in the Authorization
– When entering the Note terms into the form 147, be sure that the formatting does not result in language being cut off the bottom of the page
• State specific provisions:
– Page 5 of form 147 includes a blank page to include “State Specific Provisions”
– The Authorization, if prepared properly, will alert whether such provisions are required
3
Drafting the SBA Note (Form 147)
• State specific provisions (cont.) – Sometimes, the Authorization will tell you exactly what language to include (e.g., the “marital purpose” language in Wisconsin)
– Other times the Authorization will give the lender the option to include certain language
Personal Guarantees
• All individuals who own 20% or more of a Small Business Applicant must provide unlimited full personal guaranty (Pg. 167)
• Each spouse owning 5% or more of a Small Business Applicant must personally guarantee the loan in full when the combined ownership interest of both spouses is 20% or more
– Spouses must sign any necessary collateral documents, such as a mortgage on a residence. For spouses not required to provide a full guaranty, if collateral is required to be pledged by the spouse, the spouse should sign a limited guaranty (Form 148L)
Personal Guarantees
• Ownership by ESOP or 401(k)
– The ESOP and/or 401(k) CANNOT guaranty the loan, however
• The owner(s) of a 401(k) must provide his or her full unconditional personal guaranty regardless of the individual ownership interest in the applicant concern
• The Members of the ESOP are not required to personally guarantee the debt, but all owners of the Small Business Applicant who hold an ownership interest of 20% or more outside the ESOP are subject to SBA’s personal guaranty requirements.
• In certain change of ownership loans, the individual owner(s) and the small business MUST be co‐borrowers (see SOP pg. 119)
4
Borrower Certification
• The Borrower must sign a certification which includes all of the required provisions from the Authorization
• Even if certain provisions do not apply to the loan (such as Environmental provision related to commercial real estate on a loan where no real estate is being pledged), we still recommend that the certifications required by the Authorization are obtained
Standby Agreements
• Lender may use SBA Form 155 or its own form
• SBA Form 155
– Pros: approved by SBA; very little negotiation from borrower on SBA forms, contains the essential provisions
– Con: not a very comprehensive agreement
• Debt that is on full standby (no payments of principal or interest for the term of the SBA‐guaranteed loan) may be considered acceptable equity for SBA’s purposes
Standby Agreements
• A debt that is on partial standby (interest payments only being made) may be considered equity when there is adequate historical business cash flow available to make the payments
• SELLER carry‐back debt must be on full standby for 2 years if being used to satisfy Borrower’s equity requirement
5
Equity Requirements
• 7(a) Small Loans up to and including $350,000
– Lender must determine if the equity and the pro‐forma debt‐to‐worth are acceptable based on its policies and procedures for its similarly‐
sized, non‐SBA guaranteed commercial loans. If the lender required an equity injection and, as part of its policies and procedures for its similarly‐sized, non‐SBA guaranteed commercial loans verifies the equity injection, it must do so for SBA loans.
Equity Requirements
• Equity Requirement for loans in excess of $350,000
– Adequate equity is important to ensure the long term survival of a business. The lender must determine if the equity and the pro forma debt‐to‐worth are acceptable based on the factors related to that type of business, experience of the management and the level of competition in the market area. The lender must include in its credit analysis a detailed discussion of the required equity and its adequacy.
Equity Requirements
• SBA Express and Export Express Credit Standards
– The credit decision on SBA Express and Export Express loans, including how much to factor in a past bankruptcy or whether to require an equity injection, is left to the business judgment of the lender. Also, if the lender requires an equity injection and, as part of its standard processes for non‐SBA guaranteed loans verifies the equity injection, it must do so for SBA Express and Export Express Loans.
6
Equity Requirements
• Change of ownership
– An SBA‐guaranteed loan may be used to finance a change of ownership that includes intangible assets.
i.
If the purchase price of the business includes intangible assets in excess of $500,000, the borrower and / or seller must provide an equity injection of at least 25% of the purchase price of the business for the application to be processed under delegated authority.
ii. If the purchase price of the business includes intangible assets of $500,000 or less, i. above does not apply.
iii. If the purchase price of the business includes intangible assets in excess of $500,000 and the equity contribution from the borrower and the seller combined is less than 25% of the purchase price of the business, the application may not be processed using delegated authority and must be sent to the LGPC.
Documentation of Equity Injection
• Lenders must verify the injection prior to disbursing loan proceeds and must maintain evidence of such verification in their loan files. Lenders are expected to use reasonable and prudent efforts to verify that equity is injected and used as intended, and failure to do so may warrant a repair or partial/full denial. Lenders must submit with each purchase request on a loan for which the loan authorization required an equity injection, documentation to show that they verified the equity injection. Documentation of Equity Injection
• The SOPs provide strict requirements regarding documentation of cash equity. These requirements may be viewed as a three‐part test:
– Verification that the funds were moved into the borrower’s account or escrow (wire transfer or check)
– Verification that the funds were transferred out of the account of the contributor (prior account statements for contributors account)
– Verification that the funds are actually in borrower’s account or escrow (subsequent statement of borrower’s account or escrow settlement statement)
7
Documentation of Equity Injection
• A promissory note, “gift letter” or financial statement is not sufficient evidence of cash injection without corroborating evidence consistent with the information previously listed
Documentation of Equity Injection
• Although a slightly different transaction, this same three‐part test would be applicable to cash that is borrowed by an owner and inserted into the borrower entity; however, the Lender would need to document the additional step that the funds borrowed by the owner meet the SBA’s requirements regarding use of borrowed funds as equity (i.e. demonstration of ability to repay from other sources, etc.).
Documentation of Equity Injection
• When the source of the equity is standby debt where funds are actually injected into the company by the standby creditor, Lender should document the equity‐transaction in essentially the same manner:
– Verification that the standby borrowed funds were moved into the borrower’s account
– Verification that the funds were transferred out of the account of the standby creditor
– Verification that the funds are actually in the borrower’s account
8
Assignment of Lease
• Assignment of Lease
– Required any time a “substantial portion” of loan proceeds are used for leasehold improvements or a “substantial portion” of the collateral consists of leasehold improvements, fixtures, machinery, or equipment that is attached to lease real estate
– The assigned lease must have a term including renewal options, that equals or exceeds to the term of the loan
– The assignment of lease must include a requirement that landlord provide 60‐day written notice of default to lender with an option to cure
Landlord Waiver
• Assignment of Leases (cont.)
– Note that most leases are not assignable without the written consent of the landlord
• Make sure to obtain the landlord’s consent, if required
• Landlord Waiver
– The Landlord’s Waiver gives the lender access to the leased premises and facilitates the liquidation of the collateral on the borrower’s premises and should be obtained for all SBA loans with tangible personal property as collateral (SOP 50 10 5(H) Pg. 189)
– The Boilerplate language in the Authorization requires a landlord waiver for any leased location where the collateral is located
Landlord Waiver
• Landlord Waiver (cont.)
– In the Landlord Waiver, the landlord must agree to:
• Subordinate to Lender Lessor’s interest, if any, in the pledged collateral
• Provide Lender written notice of default and reasonable opportunity to cure (note: 60 day cure requirement discussed above)
• Allow Lender the right to take possession and dispose of or remove the collateral
• We recommend obtaining a Landlord Waiver from the EPC in an EPC/OC structure, even when the EPC is a related entity and/or co‐borrower
9
Construction
• If the construction financing has an SBA guaranty and the construction costs will exceed $10,000, the lender must obtain a completed SBA Form 601, Applicant’s Agreement of Compliance
• This must be executed by both the applicant and the contractor
Construction
• Construction: Loans over $350,000.00
• Survey – locate easements and prevent surprises
• Completed SBA Form 601 Agreement of Compliance
– Need this at a minimum for construction costs over $10,000.00
– Evidence that contractor has furnished 100% payment and performance bond
– Filed of record with contract attached
– Unless lender has engaged a 3rd party construction management service that controls disbursement of proceeds and monitors project
• Builder’s risk and worker’s comp insurance
Construction
• Satisfied equity injection – if borrower injecting funds into the project
• Plans and specs
• Construction: Loans over $350,000.00
• Construction contract in approved amount
• Retainage
• Borrower’s Agreement re: no material changes without lenders consent
• Evidence of borrower’s ability to pay cost overruns
• Lender to make interim and final inspections
10
Collateral Requirements
• Per Loan Authorization – lender must obtain a lien on 100% of the interests in the (specified) collateral and property perfect all lien positions
• Lender must take all steps necessary to maintain lien positions, subject to any approved modifications, throughout the life of the loan
• Among top reasons for repair or denial of SBA guaranty:
– Failure to obtain a required lien position
– Failure to properly perfect a security interest in required collateral
– Failure to have a personal property collateral list
Collateral Requirements
• Article 9 of the Uniform Commercial Code (UCC) governs creation, perfection and priority of security interest in personal property
• Lenders need to know many requirements and nuances in order to adequately perfect security interests in required collateral
Collateral Documents
• Although many of documents used for an SBA loan are SBA forms used in all 50 states, certain collateral documents, such as mortgages and deeds of trust, and even security agreements depending on the circumstances, are state‐
specific and must be made in accordance with the state law
• You may need to rely on documentation software or outside vendor for these documents
• Remember – all collateral documents must include the required “SBA Language”
11
Collateral Documents
• Required “SBA Language”
The Loan secured by this lien was made under a United States Small Business Administration (SBA) nationwide program which uses tax dollars to assist small business owners. If the United States is seeking to enforce this document, then under SBA regulations:
a) When SBA is the holder of the Note, this document and all documents evidencing or securing this loan will be construed in accordance with federal law.
b) Lender or SBA may use local or state procedures for purposes such as filing papers, recording documents, giving notice, foreclosing liens, and other purposes. By using these procedures, SBA does not waive any federal immunity from local or state control, penalty, tax or liability. No Borrower or Guarantor may claim or assert against SBA any local or state law to deny any obligation of Borrower, or defeat any claim of SBA with respect to this loan.
Any clause in this document requiring arbitration is not enforceable when SBA is the holder of the Note secured by this instrument.”
Perfecting Liens in Collateral
• The first step is performing proper searches and/or title work
– Obtain early in the process so that senior liens can be cleared as necessary
• Personal Property
– Perfection methods vary based on the type of collateral
• Filings UCC Financing Statement is most typical
• Security interest in some types of collateral is perfected by control, possession, noting a security interest on a lien card, etc.
• Consult with state UCC law and outside vendor as necessary
– Real Property
• A lien in real property is almost always perfected by recording the lien instrument with the county
Perfecting Liens in Collateral
• Four general methods of perfecting an attached security interest
–
–
–
–
Filing of financing statement (aka UCC‐1) – the most popular method
Collateral in possession of secured party
Secured party has control over the collateral
In a few cases, the attachment of the security interest automatically perfects the security interest
• Perfected security interest prevails over a judgement creditor and a bankruptcy trustee
– So, an unperfected security interest is subordinate to a lien creditor and a bankruptcy trustee
12
Perfecting Liens in Collateral
COLLATERAL
Accounts
PERFECTION
Filing
Agricultural Liens
Attachment; Filing
Chattel Paper
Filing; Possession; Control
Commercial Tort Claims (no perfection in after‐acquired commercial tort claims)
Filing
Commodity Accounts
Attachment (security interest created by an intermediary); otherwise, Filing; Control
Consumer Goods (other than
vehicles, boats, etc.)
Attachment (purchase money); otherwise Filing
Deposit Accounts
Control
Equipment
Filing
Farm Products
Filing
Fixtures
Filing (in county where R/E is located) 37
Perfecting Liens in Collateral
COLLATERAL
PERFECTION
General Intangibles
Filing; Attachment (sale of payment intangible)
Goods Subject to statute or treaty such as boats, cars, aircraft
Compliance with applicable federal or state regulations
Health Care Insurance Receivables assigned to a service provider
Attachment
Instruments
Filing; Possession
Inventory (including motor vehicles, boats, manufactured homes)
Filing
Investment Property Filing; Control
Letter of Credit Rights
Filing; Control Manufactured Home,
Motor Vehicle, Boats
Filing if inventory; Possession; Compliance with state regulations (non‐inventory)
38
Perfecting Liens in Collateral
COLLATERAL
PERFECTION
Membership Interest in Limited Liability Company (a subset of either General Intangibles or Investment Property)
Filing as a General Intangible; Filing or Control as Investment Property Money
Possession
Negotiable Documents
Filing; Possession; Control (electronic documents)
Partnership Interest (a subset of either General Intangibles or Investment Property)
Filing as a General Intangible; Filing or Control as Investment Property
Proceeds
Automatic if interest in the original collateral was perfected See UCC § 9‐
315(c)
Promissory Note (sale)
Attachment
Securities (a subset of Investment Property)
Attachment of account created by broker or intermediary; Filing; Control
Software (that is not part of goods)
Filing unless statute governs
39
13
Contact Information
• Wisconsin District Offices
– Milwaukee Office:
310 West Wisconsin Ave., Suite 580W
Milwaukee, WI
Phone: 414‐297‐3941
Fax: 414‐297‐1377
– Madison Office:
740 Regent Street, Suite 100
Madison, WI
Phone: 608‐441‐5261
Fax: 608‐441‐5541
Contact Information
• Standard 7a Loan Guaranty Processing Center (LGPC)
6501 Sylvan Road, Suite 122
Citrus Heights, CA 95610
Phone: 877‐475‐2435
Fax: 202‐481‐0861
• Email:
[email protected]
14