The US Small Business Administration (SBA) 504 loan program provides mortgage financing for owner-occupied business real estate and financing for capital equipment. The arrangement consists of a conventional loan from a third-party lender secured by a first mortgage on owner-occupied real estate or a first-priority security interest in equipment and an SBA-backed loan through a Certified Development Company (CDC) secured by a second mortgage or second-priority security interest in the same collateral.
Although the SBA does not guarantee or provide other direct credit enhancement for the third-party loan under the program, there are a number of SBA-imposed requirements binding on the lender. These requirements will be embodied in a Third Party Lender Agreement between the third-party lender and the CDC, which is assigned to the SBA by the CDC. The agreement addresses a number of issues. The lender must be aware of and comply with all of the agreement’s requirements. One of these requirements is discussed in detail below.
SBA Form 2287 (04-14), the standard form of Third Party Lender Agreement, essentially gives the SBA and the CDC a right of first refusal to purchase the third-party lender note and related collateral interests if the lender decides to sell the loan after default. Section 9.d. of the form agreement provides, in part, that if the loan is in default and the lender, as part of its liquidation strategy, proposes to sell the loan or receives an offer from a third party to purchase the loan:
. . . the Third Party Lender must provide CDC/SBA with the option to purchase the note at the same price offered by the potential purchaser, net any Default Charges per paragraph 9(c). SBA will have forty-five (45) days from receipt of the notice from the Third Party Lender to exercise its option to purchase the note.
Although under many circumstances it may be considered unlikely that the CDC or SBA will actually exercise this right and purchase the loan, these provisions must be taken into account when structuring and conducting a defaulted loan sale. For example, a selling lender must determine how to include disclosure of this CDC and SBA right to purchase and other effects of the Third Party Lender Agreement on the loan in its loan sale process and materials, and include the right and the 45 day waiting period in its bid acceptance and closing procedures. Also, a selling lender should not include the loan in a pool sale in which potential buyers are not required to provide separate purchase prices for each loan—since doing so would make it impossible to provide the required offer and information to the CDC and the SBA—and should retain the right to remove the loan from a pool without negating the entire bid and sale in the event the CDC or SBA exercises its purchase right. Of course, the lender must also provide the required notice to the CDC and SBA in accordance with the requirements of the Third Party Lender Agreement.
The third-party lender in an SBA 504 arrangement must be aware of and comply with all of the requirements of the Third Party Lender Agreement for that transaction. It may be beneficial to highlight these obligations up front when responsibility for the loan changes within the lender (e.g., from the SBA or mortgage lending group to the workout/special assets group or the loan sale team). It would be helpful for the newly responsible officer(s) to be aware of these requirements, at least in a general way, before planning or taking any action. This is especially important in a loan sale scenario, as these requirements must be taken into account and addressed before structuring and conducting the sale.
Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts on an ongoing basis to keep clients and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Robert Wonneberger, partner, at rwonneberger@barclaydamon.com, Janice Grubin or Jeff Dove, co-chairs of the Restructuring, Bankruptcy & Creditors’ Rights Practice Area, at jgrubin@barclaydamon.com and jdove@barclaydamon.com, respectively; or Frank Heller, partner, at fheller@barclaydamon.com.