What changed in SBA loan servicing rules for collateral, guarantor releases, and occupancy violations?

The revised SOP 50 57(3) is not only a liquidation manual. In reality, it is the complete bible regarding all aspects of SBA servicing and liquidation. Hopefully, now, all lenders will have a renewed interest in the whole of SOP 50 57 and apply it to loan modifications rather than just to liquidations.

Modification of Collateral

Take Chapter 8, Modification of Collateral. Most of the modifications SOP 50 57 makes in this section are typographical, but there are several substantive additions that could surprise some.

So why is one of these additions, a new exception for guarantor releases, necessary? This is probably answering some of the frequent lender questions raised by guarantors that have collateral they own jointly with someone else. Imagine a brother who is a limited guarantor on the debt. The limited guarantee is limited to just his interest in the property that secures the loan. The brother who is the limited guarantor isn’t an owner of the operating company, and co-owns only the investment property to be exchanged for a replacement property. The replacement property will be solely owned by the full guarantor sibling.

In such a case, this exception would allow the limited guarantor to drop off the hook as the new collateral would not even be in his name. Under SOP 50 57(3), as soon as the limited guarantor’s ownership interest in the old collateral ends, the lender can release him on its own. It doesn’t need the SBA’s prior written consent, as long as all the other conditions are met. Before, the SOP did not permit this so readily. This rule should really come in handy.

Servicing and Liquidation Actions 7(a) Lender Matrix

The Servicing and Liquidation Actions 7(a) Lender Matrix, a useful servicing reference for lenders, last updated February 25, 2020, is an out-of-date reference for SOP 50 57(3). It also does not show this change in guarantors to date. Many of these instructions still reflect the old guidelines of the past SOP. Until they are updated, do not rely solely on the Servicing and Liquidation Action Matrix checklist, but rather, read the updated section of the revised SOP text before taking or refraining from any servicing or liquidation action, even if the Matrix checklist does not say so.

New Occupancy Provision

There is also a new occupancy provision in SOP 50 57(3). If a Borrower or an Operating Company violates the occupancy requirements of 13 C.F.R. § 120.131, the SBA may accelerate the Note and demand full repayment.

It doesn’t stop there. SBA will also consider prior non-compliance on a borrower’s outstanding SBA loan when reviewing future applications, whether they come from the borrower, the operating company or any associate.

This is actually a significant departure from how SBA treated technical (non-payment) defaults in the past. A technical (non-payment) default, such as a borrower not actually occupying at least 51% of the property purchased with SBA loan proceeds, can signal financial distress, but the SBA historically has not purchased a guaranty on such a technical default alone.

If SBA actually enforces this, lenders can act earlier against struggling borrowers. It might also curb the habit of renting out excess space as sublet spaces to additional tenants. And the enforcement of the SBA occupancy requirement strongly supports the fact that SBA loans do not finance investment property.

Associates could find themselves barred from new SBA loans, at least for as long as the original loan stays in technical default.

The new technical default language is actually not addressed anywhere else in SOP 50 57(3). It remains to be seen if SBA will even enforce the new language. It also remains unclear if it adds any new tools to what lenders can use.

For these purposes, an “Associate” is any officer, director, holder of a key employee position, and anyone holding more than 20% equity in the applicant small business.