The recent U.S. economic turbulence has caused, and will probably continue to cause, challenges in lending. Borrowers, when pushed, will sometimes take actions that are not customary in the lending relationship. Below are some pre-collection and verification tips to mitigate a lender’s “loss of collateral.”
It is important to recognize that when a borrower goes into default it may be too late for a lender to protect its collateral. To minimize any collateral dissipation, lenders should explore and exercise various pre-collection activities prior to a default. The steps can include:
- Inspection. While it seems a simple step, many times lenders do not verify the existence of the collateral. Do on-sight inspections to verify all the collateral is still present.
- Compare Inspection Reports with Borrower’s Records. Lenders should compare and review inspection results with borrower’s tax depreciation schedules and balance sheets/financial statements. Do the actual inspection results correlate with the borrower’s written records?
- New Entities. It is common for borrowers as part of estate planning or business planning to transfer various assets into a trust, an LLC, and the like. Lenders should ask the borrower if it has established any new legal entities. This information is paramount to ensure that the lender has (and maintains) a security interest in the collateral with the “real” owner.
- Performing UCC, Judgment Lien and Tax Lien searches. Again, this seems simplistic but it’s important to check and verify the accuracy of a borrower’s financial statement. The searches may provide the lender with additional information as to whether or not the borrower has obtained any new secured creditors, and or if the borrower has fallen into arrears with other creditors that have obtained a judgment. against the borrower.
- Review Loan Documents.
- When a potential problem loan is identified, the lender should do a thorough review of the loan documents, to include:
- Verifying the UCC-1 financing statement properly identifies and states the business legal name, and if an individual, that the UCC-1 meets the driver’s license test (e.g. the name and spelling on UCC-1 financing statement should be identical to the information on the borrower’s driver’s license).
- Verifying the loan documents are properly signed by the borrower(s) and guarantor(s) and that all the necessary parties have signed the loan documents.
- In reviewing the loan documents the lender should also identify any unencumbered assets. Quite often, vehicles are listed as collateral on a balance sheet, but the lender has not “perfected” it’s lien in the vehicle by having its name listed as the lien holder on the title.
- When a potential problem loan is identified, the lender should do a thorough review of the loan documents, to include:
- O&E Reports. Obtain updated owners and incumbers reports on real estate loans. This will allow the lender to identify any junior creditors, tax liens, transfers of real estate (e.g., to a trust), and the like.
In summary, being proactive by investigating and taking pre-collection actions allows the lender to possibly mitigate any potential loss of collateral. If collateral is missing, the lender is in a position to take immediate action. If the inspection and pre-collection efforts do not turn up any unusual findings, the lender can feel more comfortable going into a workout situation if the borrower becomes delinquent.
