February 5, 2010

Ethan W. Smith, Partner, Starfield & Smith PC

1. When the stock of the entity is being acquired by another entity or individual(s), both the entity being acquired and the individual(s)/entity acquiring the stock must be co-borrowers on the loan. The SOP 50-10 5 (B) requires the note to be executed on "a joint and several basis by both the individual(s) who acquires the stock and the corporate entity being acquired."

2. The Loan Authorization requires the corporation to provide a certification that the corporation (or other entity) being acquired, acknowledging that: "(a) the Loan proceeds will be used to acquire all or part of its corporate stock; (b) it promises to be jointly and severally liable for the debt; (c) the Loan assistance constitutes sufficient consideration for such promise; and (d) it waives any defense relating to failure of consideration." Lenders need to insure that they obtain this certification as part of their loan documentation. Since this document is not a "typical" closing document, it can be easily overlooked.

3. It is critical to keep in mind that the buyer in a stock purchase transaction gets everything that the corporation (or other entity) owns, including all liabilities. This includes not only known liabilities and obligations, such as judgments and other liens that have been filed of record, but also contingent liabilities, which may include liability for acts or omissions of the entity which have either not yet been reduced to judgment, or for which a lawsuit has not yet even been filed. This risk requires extra diligence on the part of the lender, including: (a) review of the stock purchase agreement to ensure that it includes a strong indemnification from the selling shareholders for any contingent liabilities that are not disclosed to the purchaser; (b) run UCC, tax lien, judgment and bankruptcy searches on the company being acquired and on the selling shareholders; and (c) make sure your searches include a pending litigation search against the company being acquired to provide additional assurance as o whether there are any immediate contingent liabilities to be concerned about.

By taking these steps, lenders can minimize the likelihood of default from unforeseen contingent liabilities and, if a default does occur, maximize the chances that the SBA guaranty will be honored.

For more information on change of ownership transactions or other documentation and closing issues, contact Ethan Smith at esmith@starfieldsmith.com, or 215-542-7070.