Banks must be proactive and prepared to assist their borrowers in the uncertain times ahead. Here are several recommendations as to the things your bank can be doing to be proactive and prepared with respect to your loan portfolio.
- Review Your Loan File. Start reviewing your bank’s loan files to make sure your bank has all of the documentation in its file that it should have, and that all of the loan documents have been properly executed. It is easier to obtain a borrower’s signature on a missing document when your relationship with the borrower is good.
- Confirm the Terms of Your Loan Documents. While reviewing the loan file, confirm that the loan documents state what your bank thinks they state. Improperly drafted loan documents can cause serious problems for the bank if the loan goes bad. A common problem is where the deed of trust / mortgage refers to a prior note (not the current note) and the deed of trust / mortgage does not state it covers all future notes or other indebtedness. The deed of trust / mortgage must state the indebtedness that it secures. If the current note is not covered by the deed of trust / mortgage, the current note is not secured by that deed of trust / mortgage.
- Confirm Your Collateral. Next, confirm your bank is secured by the collateral your bank thinks it has. If the collateral description is inadequate or if a specific piece of collateral was accidentally omitted from the security agreement, now is the time to ask the borrower to sign an updated or amended security agreement. Your bank cannot obtain a security interest in collateral that was omitted from the security agreement by simply filing a UCC-1 financing statement which lists the “correct” collateral.
- Confirm Your Lien Is Perfected. In addition, confirm your bank has properly perfected its security interests in the collateral. If perfection problems are identified, immediately correct those problems because, once a bankruptcy petition is filed, it is too late to fix any perfection problems and your bank could lose all of its collateral. Common perfection problems are the failure to file the UCC-1 financing statement with the proper Secretary of State and to use the borrower’s correct legal name. Although filing a UCC-1 financing statement is the most frequently used method for perfection, specific types of collateral require different perfection methods. For example, if the collateral has a certificate of title, your bank’s lien must be recorded on that certificate of title.
- Confirm Your Priority Status. The further question is whether your bank holds the priority status it thinks it holds in the collateral. With respect to personal property, you can run a UCC search to confirm your bank has obtained priority status by being the “first to file.” Remember however, a purchase money security interest can take priority over an existing UCC-1 filing. With respect to real property, you can request an Owners & Encumbrances report from the title company to confirm your bank holds a first priority lien.
- Identify any Potential Legal Issues. This is the time for your bank to identify any potential legal issues that could negatively impact your bank’s position. A common situation is when a course of dealing has developed between the bank and the borrower which modifies the terms of a written loan document. If a course of dealing has developed in your situation, your bank will not be able to enforce those terms of the written loan document that have been modified by the course of dealing, unless your bank gives sufficient written notice and time to the borrower to change this course of dealing to require strict compliance.
It is important to realize that a forbearance agreement can be used to correct many of the deficiencies found in your bank’s loan files. Although forbearance agreements are commonly used to assist borrowers who are experiencing financial difficulty, forbearance agreements also can be used to benefit the bank without drawing attention of the borrower. For example, a forbearance agreement can be used to obtain missing signatures on loan documents, to shore up the terms of your loan documents, to correct collateral descriptions or take additional collateral, and to cut-off a course of dealing that has developed with the borrower. Other common provisions in forbearance agreements include an acknowledgment by the borrower of the total amount owed and that the borrower has no claims against your bank. So, when a borrower asks your bank for a forbearance agreement, remember to include provisions in the forbearance agreement that will benefit your bank as well, such as correcting any deficiencies your bank may have in its loan file.