When extending Small Business Administration ("SBA") loans to borrowers, it is important that lenders require appropriate insurance coverage on all collateral securing their loan.  Correctly documenting insurance coverage is vital to protect the Lender's interest in its collateral as well as to comply with the terms of the SBA Authorization. 

            If the Lender's collateral includes both real estate and personal property, the Borrower must obtain insurance coverage on the real estate as well as all furniture, fixtures, equipment and inventory which are collateral for the Loan.  Ideally, coverage should be for the full amount of the replacement cost; however, if replacement cost coverage is not available, coverage should be for the maximum insurable value of the property.  In order to properly protect the Lender's interest in real estate, the Lender must be named "mortgagee" on the policy.  If the Lender's collateral only includes business personal property (and not real estate), the Lender should be named "lender's loss payee" on the policy.  These endorsements provide the Lender with enhanced coverage and a direct contractual right to receive payment of insurance proceeds.  Moreover, the Lender's interest in the collateral will still be protected despite the actions or inactions of the Borrower.  For example, the Lender will receive insurance proceeds even if the Borrower fails to make premium payments or intentionally destroys the insured property.  (If the insurance policy only contains a regular "loss payee" endorsement, the Lender may not be protected due to the Borrower's actions or inactions.)

            The SBA requires that all casualty insurance policies provide "that any action or failure to act by the borrower or owner of the insured property will not invalidate the interest of Lender or the SBA" and that the policy "must provide for a minimum of 10 days prior written notice to Lender of policy cancellation."  The best way to ensure that this coverage is provided is to review the policy endorsements to ensure conformity with the SBA requirements.

The SBA also requires that borrowers obtain flood insurance under the National Flood Insurance Program ("NFIP") on real estate and business personal property if any portion of a building that is collateral for the Loan, or any business personal property is located in a building that is located in a special flood hazard area.  To determine if collateral is located in a flood zone, the Lender should order a Standard Flood Hazard Determination, FEMA form 81-93.  The amount of flood insurance should be the lesser of the maximum amount of insurance available or replacement cost.  It is important to note that the maximum amount of flood insurance available under NFIP programs is limited to $500,000 for both building and contents coverage, respectively.    

            While the SBA does not give clear guidelines as to what type of business liability coverage is required, lenders should use prudent lending standards.  In order to properly protect the Lender's interest, the Lender should be named "additional insured" on the Borrower's liability insurance policy.  This designation extends liability coverage to the Lender on the same terms that the insurer provides to the insured and will increase the likelihood that the lender will receive notice of a lapse in coverage. 

            If the viability of the Borrower's business is tied to an individual or individuals, the Lender must require life insurance on the key person(s) in an amount consistent with the size and term of the loan.  The Lender must obtain a collateral assignment of such policy(ies).  Such collateral assignment should identify the Lender as assignee (not beneficiary), and the assignment must be acknowledged by the home office of the insurer. 

            Depending on the specific details of each loan, lenders may also want to require borrowers to obtain marine insurance, malpractice insurance, disability insurance, workers' compensation insurance, liquor liability insurance, product liability insurance or builder's risk insurance.  Lenders should consult the SOP 50 10 5(B) and use prudent lending standards in determining what types of additional coverage are required.

Questions regarding insurance coverage for SBA loans can be directed to Katie at kobrien@starfieldsmith.com or 215-542-7070.