Jessica L. Conn, Esq.

In October 2009, the Small Business Administration issued the latest version of its Standard Operating Procedures, the 50 10 5(B). This version included a change that can affect how third party lenders structure their loans. SOP 50 10 5(B).C.1.IV.A.1. now reads as follows:

By way of background, SOP 50 10 4 briefly addressed the issue of closing a third party loan a few months prior to the debenture funding, but only in the specific context of when doing so would result in the third party loan maturing earlier than permissible. All other prior versions of the Standard Operating Procedures have been silent with respect to the issue of when and how a third party loan can begin to amortize. Therefore, until this point, there has been nothing in the SOP that would explicitly prevent a third party lender from closing and amortizing its loan at any point prior to the debenture funding, so long as it met the maturity and project percentage requirements at the time of the debenture funding.

Now, under the new guidelines, a third party lender is not permitted to close and amortize its loan before the project is complete and the borrower is operating out of the project property. The reasoning behind this new rule is that the SBA does not want businesses in the midst of construction or relocation to have to bear the burden of principal and interest payments at a time when they may not have the cash flow to support the higher debt service.

While many of these loans are for construction, and are typically underwritten with an interest only period, lenders should be mindful of situations in which they are not permitted to charge principal and interest, even though from a credit standpoint, the borrower could afford to make the payments.

This is most likely to affect loans to existing businesses. An existing business may choose to operate out of its old premises after closing for a number of reasons. The business could have time remaining on an old lease, or may simply need more time to make minor renovations and move into the new building. Either way, if the project is not complete and the borrower is not occupying and operating out of the premises, the third party lender cannot charge principal and interest on the permanent loan. Another scenario in which this issue can arise is when the loan proceeds are being used to purchase and install equipment. The borrower may be operating out of the new premises, but if the project includes equipment that has not yet been installed, the third party lender must charge interest only until such time as the project is complete.

It is important for third party lenders to be mindful of these scenarios and to communicate openly with respect to these issues to ensure that there are no missteps that prevent or delay the 504 closing.

For more information on changes to the SBA 504 program, contact Jessica Conn at jconn@starfieldsmith.com.