A Loan Participation Checklist: The Devil is in the Details

    By Dustin H. DeVore, Credit Union

    There are a number of key factors that are often missed or neglected by the originating/selling Credit Union when they initially close on a member business loan (MBL) transaction and those issues come to light when we are assisting a Credit Union considering the purchase of a participation interest in the loan. Many of these issues arise because the originating Credit Union is not represented by an attorney at closing acting in a “lender’s counsel” capacity or the borrower is not represented by an attorney that is familiar with all of the nuances associated with 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 of the closing to meet deadlines, capitalize on changing interest rates etc. It is very easy to allow key requirements to fall through the cracks. They often are not discovered until it is too late, the loan is in default and often multiple creditors are fighting over limited collateral to repay their loans.

    Below are many of the key issues that are frequently missed or not fully reviewed by the commercial loan officers of Credit Unions when closing on a commercial loan participation:

    Participation Agreement: An entire article can be written about the key provisions for a purchasing Credit Union in a loan participation agreement. The first key question on any participation agreement is whether it is a master agreement that will govern all current and future participations or an agreement that contemplates a onetime 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 (such as an unreleased deed of trust or other lien on the title of the property).

    Survey Exception in the Title Policy: Most commercial lenders will not permit the title policy to contain a survey exception, meaning that if there are any losses from an issue a survey would disclose and a survey is not provided, the lender will have no coverage.

    No Opinion of the Borrower’s Counsel: Often Credit Unions either waive this requirement or do not follow up with the borrower’s counsel post-closing for this key loan item. An opinion of 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, the loan documents do not conflict with their corporate documents, that the mortgage or deed of trust crates 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/production facility or a gas station.

    Insurance Certificate: Again, if there is real estate or other collateral of the borrower 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 loans are 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.

    Guarantors: NCUA requires the principals of the borrowing entity to guaranty member business loans in most instances. Additionally, the financial strength of guarantors is often a key factor in the underwriting of a loan. It is crucial to ensure proper guarantys were signed at closing.

    Loan File. As elementary as it sounds, the loan files sent to purchasing Credit Unions often are missing key documents or contain unsigned loan documents. The purchasing Credit Union should always be certain it has signed copies of all of the loan documents.

    In summary, the devil is in the details when ensuring that 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 Devore

    The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.