BEST PRACTICES: ESCROW ACCOUNTS

Ethan W. Smith

Although most SBA lenders do not require an escrow for real estate taxes and insurance, the ability to do so can be a powerful tool in a workout scenario with a distressed borrower that has become delinquent in the payment of these expenses. It is important that SBA lenders know the SBA's requirements for such escrows in order to remain SBA complaint in the making, servicing and liquidation of their SBA loans.

Pursuant to SBA Policy Notice 5000-857, "Escrow Policy for Commercial Real Estate Taxes and Insurance for 7(a) Loans," and the 7a Loan Authorization Boilerplate, SBA Lenders are required to include the following paragraph in the Note repayment terms when SBA loan proceeds are used to finance or refinance commercial real estate:

Lender may require Borrower to pay an additional amount into an escrow account for payment of real estate taxes and required insurance related to commercial real estate securing the loan.

It is important to note that while the language does not mandate that lenders actually escrow monies for taxes and insurance ("Lender may require..."), lenders are required to include the escrow language for all loans that re/finance commercial real estate. I would argue that best practices dictate inclusion of the language on all loans secured by commercial real estate, regardless of the use of proceeds (e.g.: a working capital loan secured by CRE).

If lenders do decide (perhaps as part of a workout plan for a distressed borrower) to escrow for real estate taxes and/or insurance, lenders should keep the following requirements in mind:

(1) The escrow account may be established for the purpose of collecting and paying the real estate taxes, hazard insurance, and flood and earthquake insurance as applicable;

(2) The escrowed amount may not exceed 105% of the actual current annual amount charged for the annual real estate taxes and insurance;

(3) The escrow account must be FDIC insured and pay the borrower the greater of a money market rate of interest, or the rate typically paid by the lender on escrow accounts for commercial real property on non-SBA guaranteed loans;

(4) In all other respects, the structure and administration of the accounts must be consistent with similar accounts for lender's conventional borrowers and lender's non-SBA guaranteed loans;

(5) Lender must remit all accrued interest on the account and provide statements regarding the account to the borrower at least annually (unless otherwise required by state or Federal law); and

(6) Upon account termination, any remaining funds must be returned to the borrower within 15 business days (SOP 50 10 5(B), pp. 217-218).

The use of escrow accounts can be a powerful tool in helping distressed borrowers get back on their feet. By keeping these requirements in mind, SBA lenders can ensure that they do not create a potential repair issue by failing to properly structure and administer these escrow accounts.

For more information on escrow account requirements and SBA eligibility and compliance issues, contact Ethan Smith at esmith@starfieldsmith.com or 215-542-7070.

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