504 projects that incorporate the use of an industrial development bond or industrial revenue bond are not new and certainly have been utilized by CDCs across the county in the past. Yet, until the issuance of the SOP 50 10 5(F), the SOP did not provide any specific guidelines or requirements with respect to the impact that a bond issuance may have on the loan structure.
When bond proceeds are being used to finance a project, the interest on those bonds can either be taxable or tax-exempt, depending on the type of bond that is issued. SBA has now explicitly stated that it cannot participate in projects financed by the issuance of a Federally tax-exempt bond, but it can participate in projects financed by the issuance of State or locally tax-exempt bonds. Therefore, 504 projects that are financed, in part, by bond financing are only eligible if the interest on the bond is taxable at the Federal level.
When projects are financed through issuance of a bond, the borrower is responsible for repayment of the bond. The bond issuer may secure the borrower's obligations in a number of different ways. In the latest version of the SOP, the SBA addresses a couple of these methods and how such methods may impact the lien of the CDC and SBA.
If the bond proceeds are being used to finance the third party loan, the SBA outlines requirements for two distinct scenarios: when the bond issuer holds title to the project property and when the bond issuer takes a lien against the project property. If the bond issuer requires that the borrower convey title to the project property to the bond issuer, two requirements must be met in order for SBA to agree to a subordinate lien to the third party lender. First, the third party lender and the CDC/SBA's liens must be recorded before title in the project property is transferred to the bond issuer. If the bond issuer will hold title to the property during repayment of the bond, it will lease the property back to the borrower during this time. In such a case, the bond issuer must assign the lease to the third party lender and the payments under the lease must be made to the third party lender and serve as payments under the loan. If the bond issuer is not holding the real estate, but rather, is encumbering the real estate with a lien, then the SBA will agree to a subordinate lien position to the third party lender, but will not agree to a subordinate lien position to the bond issuer.
The bond proceeds can also be used to fund the borrower's contribution under certain circumstances. Again, if the bond issuer will hold title to the project property, the third party lender and the CDC/SBA's liens must be recorded before title in the project property is transferred to the bond issuer. If, instead, the bond issuer will take a lien against the project property, the CDC/SBA's lien will not be subordinate to the lien of the bond issuer. Finally, the borrower cannot repay the obligations arising under the bond at a rate that is faster than the 504 loan, unless approved by SBA.
The new section to the SOP on bond financing ends with two general conditions that would appear to apply regardless of how the bond financing proceeds were used. The SBA explicitly states that a default in payment of the tax-exempt obligation cannot result in a tax lien on the property. The process by which a CDC fulfills this requirement may vary by state. Ultimately, the SBA's goal is to protect the CDC/SBA's senior lien in the project property by preventing the bond issuer from placing a lien that, in some cases, may trump a mortgage lien filed first in time. The SBA also states that SBA may agree to take a subordinate lien position in additional collateral, should the bond issuer take collateral other than the project property.
It is important to be aware of these new guidelines and to seek further guidance from district counsel when utilizing bond financing in a 504 loan project. For more information about 504 Loans and bond financing, please contact Jess at jconn@starfieldsmith.com at 215.542.7070.
