Avoiding Lender Liability in Commercial Loan Originations
When working with a prospective borrower, lenders should take the steps necessary to avoid the potential of future lender liability claims in the event that the relationship between the borrower and lender deteriorates. In terms of commercial lending transactions, “lender liability” generally refers to claims by a borrower (or other obligor) against a lender which, if successful, could result in a lender being held liable for losses suffered by the borrower (or other obligor) caused by the lender’s actions, or failure to act. Lender liability claims are often based on various legal arguments such as breach of contract, breach of duty of good faith, negligence or willful misconduct, or violations of applicable laws and statutes. There are many proactive practices that lenders may utilize to avoid, or limit, the potential exposure of lender liability claims, such as the following: Confirm who will be the primary point of contact for the borrower to avoid potential inconsistent discussions or communications. Verbal negotiation of terms and conditions may give rise to future disputes between a lender and borrower. Lenders should summarize any verbal negotiations in writing to minimize the potential of misunderstandings, misinterpretations, or confusion. Proposal letters or letters of intent should include a disclaimer of any commitment to extend credit until final approval is issued through the lender’s loan approval process. Commitment letters may be considered a binding contract between the lender and borrower, and a lender’s failure to abide by terms of the commitment letter may give rise to a lender liability claim. Accordingly, lenders should determine whether their form of commitment letter contains any applicable conditions or prerequisites for the proposed loan. Obtain a signed acknowledgement from the borrower and/or guarantors confirming their obligation to reimburse lender for any costs or expenses incurred by the lender, regardless of whether or not the loan closes. Ensure that all applicable consents and waivers are obtained, and control who is provided access to confidential borrower information and other due diligence materials. Avoid preparing or negotiating documents on behalf of the borrower (e.g. negotiating terms of a purchase agreement with seller or seller’s counsel). Ensure that specific loan provisions and covenants are consistent with the lender’s loan approval requirements, as well as the negotiations with the borrower, such as: Financial covenants and ratios Financial reporting requirements Borrower affirmative covenants Borrower negative covenants Lender obligations and commitments (e.g. obligatory vs discretionary advances) Modifications to the loan documents must be in writing and only effective if signed by the appropriate parties. Merger clause stating that the loan documents contain the entire agreement of the parties. Accurately detailing the order of application of payments. Ensure consistency between documents in a singular transaction. Ensure consistency between documents for multiple loans for the same borrower. Ensure that all documents are executed and/or acknowledged properly by all necessary parties. Ensure that loan proceeds are properly distributed according to the terms of the loan documents. While this is not an exhaustive list, it is meant to provide examples of best practices to assist lending institutions in ensuring that their commercial loan processes minimize potential lender liability claims.
Read moreSecuring Aircraft Assets published by Jellum Law
Securing high-value aircraft, aircraft engines and other aviation assets present unique challenges for most lenders that take a security interest in aviation assets infrequently. Although no particular form is preferred, and lenders often use a variety of instruments, the Federal Aviation Administration (“FAA”) provides a form security agreement that may be used. Aviation assets rarely have fixed locations, and legal jurisdictions for filing and enforcement have differing requirements for the treatment of security agreements. This creates more uncertainty for lending institutions. The below, while not exhaustive, provides an overview of some of the common ways to properly identify and perfect the security interests in such assets reflected in the chosen security agreement. Common Ways to Perfect a Security Interest in Aircraft and Associated Aviation Assets 1. Recording the Security Agreement with the FAA. According to the Federal Aviation Administration (“FAA”), the security agreement to be recorded must: (1) give the names of the parties to the agreement; (2) contain words which state the aircraft owner grants the secured party a security interest in the collateral; (3) identify the collateral by manufacturer name, model designation, serial number, and N-Number (the alphanumeric string appearing on the side of U.S. commercial aircraft); and (4) contain the ink signature(s) of the debtor/aircraft owner(s) showing signer’s title, as appropriate (the Registry may now accept copies of legible digital signatures). The filing must also include the required recording fee for each item of collateral. Maximum secured amounts or other economic terms are often included, but are not required for the security instrument to be recorded with the FAA. Typically, security instruments establish a secured interest in the airframe and/or engine. Engines and propellers capable of more than 750 rated take-off horsepower, and air carrier spare parts locations may be so identified. The manufacturer name, model name and serial number to describe engines and propellers will need to be provided. For spare parts location(s), the address, including city and state, will need to be identified. Once the security agreement is successfully recorded, the FAA will return to the secured party a Conveyance Recordation Notice, which can be used as a release if signed by the secured party and properly returns it to the Aircraft Registration Branch of the FAA. 2. Recording the Security Agreement Through Cape Town Convention Treaty. The Cape Town Convention Treaty (“Treaty”) applies to “aircraft objects”, which include airframes and aircraft engines that meet the following size requirements: (1) an airframe must be type certificated to transport eight persons including crew or goods in excess of 2,750 kilograms; and (2) an engine must have 1,750 pounds of thrust (or its equivalent) or 550 rated take-off horsepower (or its equivalent). Aircraft equipment not meeting these size requirements are not subject to the Treaty. In addition to meeting the size requirements, the debtor, lessee or seller must be “situated” in a Contracting State in order for the interests created by transaction documents to be covered by the Treaty. If the aircraft is subject to the Treaty, it is recommended that a secured party file its security interests in aircraft airframes, engines and other associated aviation assets […]
Read morePerfecting Security Interests in Various Collateral
Commercial loans are often secured by a borrower’s business assets, which frequently includes items like equipment, inventory, accounts receivable, and real estate. Most lenders are very familiar with these types of collateral and are comfortable perfecting their security interests in such collateral by filing a UCC Financing Statement or Mortgage in the appropriate state or county offices, as applicable. However, depending on the nature of the borrower’s business or the details of the specific loan transaction, lenders may also seek to perfect a security interest in other types of collateral that would not always be covered by a UCC Financing Statement or Mortgage. Many borrowers are owners of various licenses, which can be very valuable, and lenders frequently require that such licenses serve as collateral for their loan. It can be easy to assume that such licenses would be covered by a lender’s “all business assets” UCC Financing Statement, but that is not always the case. For example, depending on the state where a borrower is operating, a lender may or may not be able to take a security interest in a borrower’s liquor license. Some state statutes explicitly prohibit such security interests, while others may either allow such security interests or allow the future transfer of the license, so it is important for lenders to understand the laws and procedures in the state where their borrower is operating. Similarly, a borrower that operates a radio station will normally have one or more Federal Communications Commission (FCC) licenses that allow them to operate and broadcast various content. These licenses are valuable, but they cannot be pledged as collateral for a loan because such security interests are currently prohibited by the FCC. Instead, a lender can attempt to take a security interest in the proceeds of the sale of such licenses, which would generally be perfected by adding additional language to the Security Agreement and related UCC Financing Statement. Patents, copyrights, watercraft, and aircraft are also examples of common collateral that may require more than the usual UCC Financing Statement. For instance, patents and copyrights should be perfected with an appropriate UCC Financing Statement as well as the filing of a Security Agreement with the United States Patent and Trademark Office or United States Copyright Office, as applicable. Similarly, security interests in watercraft may also require the filing of documentation with the U.S. Coast Guard, and security interests in aircraft may require additional documentation to be filed with the Federal Aviation Administration.
Read moreNews Flash: SBA’s Interim Final Rule
On February 10, 2020, The Small Business Administration (SBA) published an interim final rule and request for comments in the Federal Register. This interim final rule was published after receiving extensive comments from the public following the release of the SBA’s Notice of Proposed Rulemaking on Express Loan Programs; Affiliation Programs on September 28, 2018. Rather than proceeding to the final rule, the SBA is providing the public with an additional opportunity to comment. The final rule provisions will impact major SBA loan programs including those related to: SBA Express Affiliation Agents and Fees Personal Resources Test While the SBA is continuing to invite comments on all aspects of the interim final rule until April 10, 2020, the majority of the new provisions will take effect on March 11, 2020. Changes related to agents/fees will take effect October 1, 2020.
Read moreTaxpayer First Act
Over the past several weeks, we have had multiple discussions with our clients regarding the amended provision to Section 2202 of the Taxpayer First Act of the Internal Revenue Code section 6103 (c) (which went into effect on December 28, 2019) requiring the taxpayer to provide consent for the express purpose for which their tax information will be used and shared with other parties. In light of the discussions with our clients, we are providing the following sample consent language. When determining the form of implementation of the consent language lenders should be mindful to obtain consent from all necessary parties, which may include borrowers, guarantors, and sellers. SAMPLE TAXPAYER CONSENT LANGUAGE “The undersigned hereby understands, acknowledges, and agrees that ____________________________________ (“Lender”) and the other “Receiving Parties”, as hereafter defined, are authorized to obtain, use and share the undersigneds tax return information for purposes of (i) providing a loan proposal; (ii) originating, maintaining, managing, monitoring, servicing, selling, insuring, or securitizing a loan and all collateral for any such loan; (iii) marketing purposes; or (iv) as otherwise permitted by applicable laws, including state and federal privacy and data security laws. The term “Lender,” as used above, includes Lender’s affiliates, agents, (including, but not limited to, attorneys, accountants, appraisers, brokers and lender service providers), and any of aforementioned parties’ respective successors and assigns. The term “Receiving Parties,” as used above, includes (i) any actual owners of a loan resulting from a loan application or guarantee thereof, as applicable, (ii) any potential purchasers of a loan resulting from a loan application or guarantee thereof, as applicable, or (iii) any acquirers of any beneficial or other interest in the loan (including, but not limited to, the United States Small Business Administration), any mortgage/title insurer, guarantor, any servicers or service providers for the forgoing parties and any of aforementioned parties’ respective successors and assigns.” It is important to note that the aforementioned Taxpayer First Act consent requirements do not apply solely to federally guaranteed loan programs. Please contact Your SBA Legal Department® at SBAQuestions@JellumLaw.com with any additional questions.
Read moreEnsuring Your Collateral is Properly Insured
When lending money to businesses, lenders typically require borrowers to provide evidence that the collateral securing their loan is adequately insured. Not only does the borrower need to have the correct type of coverage and the correct amount of coverage, but lenders also need to work with borrowers and their insurance agents to ensure lenders are properly named on those policies. In the event of a loss, a lender’s status on the applicable insurance policy can become an important factor in their ability to obtain the proceeds of the policy. The proper type of insurance coverage can vary from borrower to borrower, but in most cases, lenders will want to ensure their borrowers have liability insurance and property insurance (including business personal property and real estate, as applicable). Depending on the borrower’s business, they may also need additional coverage, such as workers’ compensation insurance, business interruption insurance, liquor liability insurance, or professional malpractice insurance. The best practice for lenders is to ensure all this coverage is in place by the time their loan closes. The proper amount of coverage can also vary from borrower to borrower and often depends on the type of collateral involved. Depending on the value of the collateral and the size of the loan, a lender may choose to require a borrower to obtain certain levels of liability and property coverage. In many cases, for policies that cover real property or personal property, lenders will require borrowers to obtain full replacement cost coverage or, if such amount is unavailable, coverage for the maximum insurable value. Once lenders confirm their borrowers have the correct type and amount of coverage, they need to take the crucial next step of being named on their borrower’s policies. This allows a lender to recover directly from the insurance company in the event of a loss. Typically, for liability insurance, lenders should be named as Additional Insured, and for property insurance that covers real estate, lenders should be named as Mortgagee. When it comes to business personal property, there are usually two options for lenders to be named on their borrower’s policies – they can be named as Loss Payee or Lender’s Loss Payee. While these two terms are very similar and sometimes erroneously used interchangeably, there is a key difference that is important for lenders. If a lender is named as Loss Payee and there is a covered loss, the insurance company would make the check payable to the lender and the borrower. However, if there was any reason why the insurance company would not be required to make a payment to the insured (borrower), such as a breach of the policy terms by the borrower, then the lender would also not receive payment. The option that affords the lender more protection is being named as Lender’s Loss Payee. Being named as Lender’s Loss Payee entitles lenders to payment, even in situations where the insured may not be entitled to payment due to their non-compliance with the terms of the policy. Finally, when collecting documentation to verify adequate collateral insurance, it is important to remember that while the commonly used ACORD […]
Read moreNew SAM Requirements: Documenting SAM Review as Part of Due Diligence
On September 18, 2019, the United States Office of Inspector General completed an audit of the SBA . One of the recommendations of that report was that additional steps be implemented “to prevent ineligible individuals or entities from participating in small business programs.” Entities suspended, debarred, declared ineligible, or otherwise excluded from participating in government programs are maintained in the System for Award Management (“SAM”). As a result, SBA plans to “update the [SOP] to include a requirement for lending partners to review SAM for applicants’ and borrowers’ eligibility and maintain documentation in the loan file to support their review.” SBA intends to complete final action on this recommendation by January 31, 2020. This news is particularly important for SBA lenders, as the SBA puts the onus on lenders to ensure that applicants and borrowers are eligible to do business with SBA. As set forth in SOP 50 10 5(K) : Lenders are responsible for consulting with System for Awards Management’s (SAM) Excluded Parties List System (EPLS) or any successor system to determine if an employee or an Agent has been debarred, suspended or otherwise excluded by SBA or another Federal agency. Significantly, the requirement to search SAM and EPLS applies both to applicants and to the employees of the lenders. To that end, lenders should verify the eligibility of both customers who seek SBA loans and employees who work on the transactions. Currently, the SOP does not offer any real guidance on how to document searches of SAM or EPLS. SBA will be addressing the concerns raised by the Office of the Inspector General by requiring lenders to “maintain documentation in the loan file to support their review” in the new SOP. What is less clear, however, is whether the SBA’s new SOP will deal with how often the searches should be conducted. As a practical matter, lenders should already be documenting their SAM and EPLS searches. Otherwise, a lender is unable to show compliance with the requirement that the searches be conducted. Failure to do so may result in denial of the SBA guaranty were losses occur on loans made to ineligible entities or worked on by ineligible employees. Accordingly, lenders should document the date, time, and scope of SAM and EPLS searches for both employees and customers. Searches of SAM and EPLS should be done before the loan is approved. One way to document the searches is to either print or screen capture search results. Lenders should also keep a log of searches in each loan file. New searches should be done at least quarterly to ensure that the information is current and correct. As the situation develops, Jellum Law remains dedicated to ensuring our clients have the most up-to-date information regarding SAM and EPLS documentation requirements. If you have questions regarding the Office of Inspector General report, please feel free to contact Your Legal Department ® at Questions@JellumLaw.com.
Read moreStrategies for Managing the Commercial Loan Post-Closing Process
After a commercial loan transaction closes, it’s easy to feel that all the important work has been completed, but the truth is there are many post-closing matters that still require the lender’s attention. Often, the tasks that must be performed after a loan closing involve perfecting the lender’s collateral liens, and in many situations, lenders need the borrower’s cooperation in order to satisfy post-closing requirements. However, borrowers are often eager to focus on managing their businesses, creating difficulty for the lender to redirect their attention back to the loan closing. Taking an opportunity during the closing process to define and communicate the responsibilities of each party, including post-closing expectations, can help simplify the cumbersome post-closing process for lenders. A crucial step in an efficient post-closing process is letting borrowers know that their cooperation may still be required after a loan closes, which is why we recommend using a Post-Closing Agreement with all loan transactions. These agreements outline specific requirements that need to be satisfied post-closing, and they provide an opportunity to manage the borrower’s expectations while informing them that they still have a responsibility to communicate and work with their lender after their loan closes. It is advisable that all post-closing requirements have specified deadlines listed in the agreement. Another document we recommend lenders use is an Errors and Omissions Agreement. This document requires borrowers to provide additional information and execute additional documentation, as may be required by the lender after a loan closing. The closing process presents several opportunities for mistakes to be made, including omitting certain documents from the closing document package, incorrect signatures on documents, and execution of outdated versions of documents. The Errors and Omissions Agreement is a good way for all parties to agree to resolve these potential issues after closing. An additional tool that lenders can use to help manage post-closing issues is the Loan Agreement. A good Loan Agreement clearly outlines each party’s ongoing responsibilities, and in doing so, helps manage the borrower’s expectations. Loan Agreements are particularly useful in more complicated transactions because the agreements can be tailored to fit various scenarios and include additional terms a lender may require. The Loan Agreement may include events of default should the borrower fail to satisfy any post-closing requirements prior to the applicable deadlines. Depending on the type of collateral involved in a transaction, there can be many different potential post-closing issues for a lender to track and resolve. Real estate is a good example of a potentially complicated type of collateral to deal with post-closing because it involves ensuring mortgages get recorded properly, tracking receipt of recorded documents and final title policies, confirming the adequacy of title policies, and working with title companies to resolve any issues or unexpected exceptions that may appear on a final policy. Automobile liens can also be especially tricky, and not only require the correct documentation from the borrower, but also may require substantial interaction with the DMV in the state where the vehicle is titled. Additional post-closing responsibilities include review of executed loan documents, filing UCC financing statements, obtaining confirmation of UCC terminations, tracking financial reporting covenants, […]
Read moreEnvironmental Considerations in SBA Gas Station Loans
Loans made to or involving gas stations can present the lender with some unique environmental concerns. As such, the SBA Standard Operating Procedures (“SOPs”) include specific requirements for all loans secured by a lien or security interest on real property (a fee simple or leasehold mortgage, deed of trust, etc.) or personal property (gas station fixtures or equipment such as tanks, pumps, lines, etc.) currently used to operate a gas station or commercial fueling facility (which the SOPs refer to as “Gas Station Loans”). The SOPs include specific environmental investigation requirements for Gas Station Loans, which are set forth in Appendix 5 of SOP 50 10 5 (H). The environmental investigation for all Gas Station Loans must begin with a Phase I ESA, which must be conducted by an independent “Environmental Professional” (generally, “a person who possesses sufficient specific education, training, and experience necessary to exercise professional judgment to develop opinions and conclusions regarding conditions indicative of releases or threatened releases on, at, in, or to a property” (see 40 CFR 312.10(a) for full definition)). The Phase I must include an analysis of all relevant documents for not only the subject property, but also adjoining properties. The environmental investigation must also include a determination as to whether the gas station is in compliance with all state requirements pertaining to tank and equipment testing. If the Environmental Professional recommends any further investigation (such as a Phase II), such investigation must be made. If the results of the environmental investigation are that the property is not contaminated, lenders submitting loans through general processing must submit the investigation to the SBA with recommendations and seek SBA’s concurrence. Lenders processing PLP, 7(a) Small Loans, SBA Express and Export Express loans, do not have to submit the environmental investigation reports to the SBA but they must keep a copy of any report in the loan file. If the results of the environmental investigation are that the property is contaminated, and the lender wishes to continue with the loan, the lender must follow the requirements set forth in the sections of the SOPs entitled “Approval and Disbursement of Loans When There is Contamination or Remediation at the Property” (See SOP 50 10 5 (H), Section III –Environmental Policies and Procedures, paragraph G, at page 179). This includes, but is not limited to, submission of a recommendation to the SBA that includes a discussion on such topics as the nature and extent of the contamination, status and recommended method of remediation, collateral value, and any mitigating factors. Further, if the results of the environmental investigation are that the property is contaminated and the loan is for the purchase of the gas station, in most instances SBA’s form of Environmental Indemnification Agreement (found at Appendix 6 of SOP 50 10 5 (H)) must be signed by the seller. Also note that, if any fuel supplier, oil company or other party, such as a seller, has a right to indemnification from subsequent owners of the property, then that party must execute either the SBA form of Environmental Indemnification Agreement or some other document in which they waive and release […]
Read moreMortgage Registration Tax in Minnesota on Mortgage Modifications
When filing a mortgage, determining the amount of mortgage registration tax (“MRT”) is relatively simple. Except in the counties of Ramsey and Hennepin, MRT is calculated by simply multiplying the amount of the debt secured by the mortgage by .0023. In Ramsey and Hennepin, the calculation is the same except the multiplier is .0024. Determining whether or not MRT is due and payable when a mortgage amendment or modification is filed may not be as simple. Under Minnesota Statutes Section 287.05, subdivision 8, no MRT is due if the amendment does not secure new or increased debt. Thus, if the purpose of a mortgage modification agreement is to add new property to be encumbered by the mortgage lien or to require a real estate tax escrow, it’s clear that no additional MRT is due. However, what happens when your mortgage originally secured $100,000, it’s now paid down to $25,000 and the borrower wants to borrow an additional $50,000. Assuming your original loan was a term loan, the result of this would be that MRT is now due and payable on the additional $50,000 being advanced to the borrower. This is required because, despite the fact that the new amount secured is still less than the original $100,000, the additional $50,000 is both new debt and an increase from the paid down original amount secured by the mortgage. On the other hand, if the original loan was a revolving line of credit, no MRT would be due on the additional $50,000 so long as your original mortgage contained the statement that the mortgage secures a revolving line of credit under which advances, payments and readvances may be made from time to time. This is the case because the additional $50,000 is a continuation of the existing debt secured by the original mortgage, making it neither new or an increase.
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