By: Timothy D'Lauro, Esq.  

 

Timothy D'Lauro, Esquire

 

When underwriting an SBA loan, a Lender has many different issues to consider. The Lender must evaluate the Borrower and decide whether or not lending money to the Borrower is an acceptable risk. In addition to the real estate, personal property, and other types of collateral the Lender uses to secure the loan, the Lender will also look for other ways to mitigate its risk. One of the ways that Lenders accomplish this is to require owners, or other key parties to the business to obtain life insurance, the proceeds of which are assigned as collateral for the loan.

Under the SOP 50 10 5 (E) at page 209, the SBA lays out the requirements for when life insurance is required, how much, and when life insurance is not necessary. The rule set forth in the SOP is that life insurance must be required if the lender determines that the "business operations [will] be adversely affected and the loan default" in the event the individual dies. The only exceptions to this rule are for situation where the Lender determines that the "adequacy of collateral and/or the presence of secondary sources of repayment" render life insurance unnecessary.   The rule goes on to state that "if there is a loss on the loan due to the death of the owner, the lender will be responsible for the loss." Basically, this means that lenders are given the discretion to waive life insurance as a loan requirement in certain circumstances, with the proviso that if the lender waives the requirement and there is a loss due to the death of an owner that is not covered by the life insurance, then the Lender is solely responsible for that risk and any losses associated therewith. Accordingly, the decision to waive the life insurance requirement is not one that should be made lightly, and is one that should be well documented and justified in the Lender's credit file.

The next consideration a Lender needs to make after it decides whether life insurance is necessary, is how much life insurance is required. The amount of the life insurance must be commensurate with the size and term of the loan. However, the Lender may also take into account the amount and types of collateral securing the loan. If the Lender obtains a collateral which it believes can be liquidated to pay down the loan, it may offset the amount of life insurance be obtained by the liquidation value of the collateral. For example, if the Lender is providing a $1 million dollar loan, and it is secured by real estate with equity of $400,000.00, the Lender could require that the Borrower obtain life insurance for the difference between the full loan amount and the amount of collateral, or $600,000.

Once the Lender determines whether and how much life insurance is required, the Lender must then obtain a collateral assignment of the policy, naming the Lender as Assignee, and acknowledged by the Insurer's Home Office. The Lender must also monitor the policy to ensure that insurance premiums are being paid and kept current during the life of the loan. In order to do so, the Lender may consider escrowing funds to pay the insurance premium, provided that the escrow account complies with the SBA guidelines regarding escrow accounts.

The decisions a lender makes regarding life insurance for SBA loans can be critical to maintaining the integrity of the SBA guaranty. By following the SBA guidance regarding life insurance summarized above, Lenders can avoid costly repairs and denials.

For more information regarding life insurance, please contact Tim at (215) 542-7070 or at TDlauro@StarfieldSmith.com.