There are a number of key details often missed when credit unions close on a member business loan. We see these when we are helping a credit union client decide whether to buy a participation interest in such loans.
Many of these issues arise because the originating credit union is not represented by an attorney at closing who is acting in a “lender’s counsel” capacity, or because the borrower is not represented by an attorney familiar with all the nuances of commercial transactions.
As anyone who has been involved in a significant number of commercial closings will tell you, there is often a mad rush the last few days leading up to the closing as deadlines need to be met and the parties work to capitalize on changing interest rates, etc. It’s very easy to allow key requirements to fall through the cracks. They often aren’t discovered until it’s too late, the loan is in default and creditors are fighting over limited collateral to repay their loans.
Below are key issues frequently missed or not fully reviewed by credit unions closing on a commercial loan participation:
The first key question on any participation agreement is whether it’s a master agreement that will govern all current and future participations, or is it an agreement that contemplates a one-time purchase? Has the agreement been reviewed by legal counsel?
No Lender’s Title Policy
If the commercial loan is secured by real estate then a lender’s title policy is crucial to protect the lender against losses due to title issues. Those can include an unreleased deed of trust or other lien on the property title.
Survey Exception In The Title Policy
Most commercial lenders will not permit the title policy to contain a survey exception. A survey exception means that if there are any losses from an issue that a survey would have disclosed and a survey is not provided, then that lender would have no coverage.
No Opinion Of The Borrower’s Counsel
Credit unions often waive this requirement or don’t follow up with the borrower’s counsel post-closing for this key loan item. The borrower’s counsel at a minimum should provide the originating credit union a legal opinion that the borrower and corporate guarantors are in good standing, that the loan documents don’t conflict with their corporate documents, that the mortgage or deed of trust creates a valid and enforceable lien against the real estate securing the loan, and that the security agreement creates a valid lien against any non-real estate collateral (such as equipment).
No Phase I Environmental Inspection Required
If the loan is secured by real estate, a Phase I environmental Inspection should typically be required. This is especially critical if the real estate securing the loan is a manufacturing or production facility or a gas station.
Again, if there is real estate or other collateral securing the loan, the lead lender should require a certificate of insurance insuring the collateral, and that certificate should name the lender as an additional insured.
Filing Of UCC-1 Financing Statements
Commercial loansare frequently secured with both real estate and other collateral such as furniture, inventory, and equipment. In most states in order to secure a lien on these types of collateral a security agreement alone is not enough to “perfect” the lien, it only attaches a lien to the collateral. In order to perfect such a lien, a UCC-1 must be filed with the state corporation commission or other filing office. If the lender fails to file the UCC-1, the lender’s lien will have no priority in the event of the need to foreclose on the collateral and collect on the loan.
The NCUA requires the principals of the borrowing entity to guarantee member business loans in most instances. Additionally, the financial strength of guarantors is often a key factor in underwriting a loan. It’s crucial to ensure proper guarantees were signed at closing.
Loan files sent to purchasing credit unions often are missing key documents or signatures. As elementary as it sounds, the purchasing credit union should always be certain it has been sent signed copies of all documents.
In summary, the devil is in the details when ensuring a loan participation is properly documented. Careful due diligence and competent legal representation are critical for a credit union to make its loan participations a success.
Dustin H. DeVore is co-chair of Kaufman & Canoles’ Credit Union Team and works closely with a number of credit unions on regulatory and lending issues. He can be reached at (757) 259-3808 or firstname.lastname@example.org.
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