The Antideficiency Act (the "Act") prohibits federal employees from making or authorizing an expenditure from, or creating or authorizing an obligation under, any appropriation or fund in excess of the amount available in the appropriation or fund unless authorized by law. 31 U.S.C. § 1341(a)(1).  It also prevents them from involving the government in any obligation to pay money before funds have been appropriated for that purpose, unless otherwise allowed by law.  Id. Federal employees who violate the Act are subject to two types of sanctions: administrative and penal.  According to the U.S. Government Accounting Office, "[e]mployees may be subject to appropriate administrative discipline including, when circumstances warrant, suspension from duty without pay or removal from office. In addition, employees may also be subject to fines, imprisonment, or both."

Now, you may be asking yourself what does this have to do with the SBA 504 loan program? Recently, CDC's have found themselves challenged when SBA employees, concerned about their potential liability for violating the Act, have refused to approve 504 debenture packages for funding because of the risks associated with contingent, indemnification or hold harmless provisions found in covenants burdening real property which could potentially obligate the federal government should the government take title to the property in the future.  This issue, once a rare, isolated issue encountered predominantly in the western United States, is now reaching all states in the union.  According to NADCO, this issue is now affecting CDCs nationwide and is delaying funding for already approved loans.  Finding a solution has become a priority for advocates of the 504 Loan Program.

Oftentimes, indemnification provisions, which are frequently "buried" in easements or other documents affecting the project property, are the culprits that give rise to these antideficiency concerns.  The concept of indemnity shifts the liability for loss from one person held legally responsible to another.  Indemnity or hold harmless agreements provide reassurances for reimbursement in case of an anticipated loss and are quite common clauses in real estate development documents.  For instance, easements and other agreements affecting access to real property, generally contain indemnification or hold harmless provisions in favor of government entities or developers who may be called upon in the future to incur expenses in connection with the maintenance of the easement.

Fear of obligating the government under the terms of an indemnification or hold harmless agreement and theoretically submitting the agency, or a particular individual, to the prescribed penalties of the Act had led some SBA employees to withhold approval of 504 debenture packages until indemnity or hold harmless covenants affecting project real property, are revised to eliminate the contingent liability to the federal government.  Currently, the only solution is to eliminate the risk from the offending indemnity or hold harmless provision by amending the recorded agreement.  Unfortunately, this ad hoc approach can be costly, time-consuming and unpredictable.  In an effort to resolve this untenable situation, the Agency plans to release guidance that should mitigate this issue by the end of September.  In the meantime, the best practice is to review all covenants running with the land carefully to examine them for any indemnity or hold harmless provision at the earliest possible opportunity.  This is of particular importance in ground-up construction projects, or acquisition of existing buildings, that are part of large, planned commercial developments.  Timely detection will allow the lender, CDC and borrower to deal with this issue early on in the process, before expectations are set and substantial financial investments are incurred.

For questions regarding this topic, contact Victor at 407-618-0694 or at vdiaz@starfieldsmith.com.