What this is: When Valentine’s Day rolls around, we’re hunting for the perfect gift to make someone feel appreciated and secure. Just like you might do a little research to ensure your gift matches the recipient’s tastes and needs, it’s essential for lenders to perform their own kind of due diligence. Before extending credit, they want to make sure a potential borrower is a good fit and a reliable risk, much like confirming that your gift will hit the mark and bring a smile.
What this means: Review the 7 types of searches that are important for lenders to keep in mind for a comprehensive due diligence strategy.
What is Lending Due Diligence?
Due diligence is a vital process across a plethora of business settings that involves inspecting the public record for outstanding liens, litigation and bankruptcy cases that could impact the assets pledged as collateral in a transaction. In the lending world, specifically, due diligence searches are necessary to verify that a borrower is a practical risk for the lender.
1. UCC Search
Why is the Uniform Commercial Code Important to Lenders?
The Uniform Commercial Code (UCC) is a group of statutes that governs secured transactions (among other things) in a streamlined manner across all US states. Lending professionals rely on the framework of the UCC to ensure their security interests in a borrower’s assets are accurately established and protected.
A UCC search is carried out to determine if a business’s assets are collateral for a prior debt. This is key for lenders, creditors and other interested parties to evaluate the risk correlated with extending credit or entering into financial agreements. UCC searches are also conducted after filing to ensure the lender’s filing was properly indexed, ensuring the creditor’s security interest is “perfected” and has the intended priority among other creditors. Additionally, these searches are conducted throughout the life of the loan to make certain that a lender maintains priority over a borrower’s collateral.
2. Tax Lien Search
Federal and state tax liens are legal claims against property for unpaid taxes. A search for tax liens can reveal unpaid taxes only if the IRS or local tax office has taken the steps to file the lien. These liens are important for lending due diligence because they point to financial instability or hinder the property being used as collateral. A potential borrower may have hidden tax debt which can be uncovered through a more thorough look into the IRS records.
Get help managing UCC and IP due diligence across jurisdictions.
3. Judgment Search
A judgment is the official decision of a court of law granting or denying a plaintiff’s claim and is found in the court records. A judgment search reveals court judgments against a potential borrower, providing critical insight into their financial and legal status while potentially revealing unresolved financial obligations including settlements or unpaid debts. Judgments are non-consensual and could lead to liens, threatening the ability to recover funds in the event of default.
Important note: A request for a judgment search during the due diligence process must differentiate between a judgment and a judgment lien as, contrary to popular belief, the results of a judgment search do not always include judgment liens. More on judgment liens below.
4. Judgment Lien Search
A judgment lien is nonconsensual and can be best described as a liability or security interest placed on a debtor’s property to satisfy a judgment issued in court. A judgment lien search uncovers legal claims on a borrower’s property.
Summary of the Difference Between a Judgment Search and a Judgment Lien Search
- A judgment lien search centers around whether those liabilities have brought about secured claims against personal property and/or real property assets.
- A judgment search provides a broad rundown of a borrower’s legal and financial liabilities via court rulings.
5. Pending Litigation Search
Pending litigation pertains to unresolved and active legal disputes within the judicial system. A search of these records uncovers active lawsuits or pending legal actions against a seller, borrower or guarantor, highlighting potential risks to their ability to repay a loan. Such searches also have the potential to reveal litigation that could affect the value of collateral.
Where Should Litigation Searches Be Conducted?
For entities, searches should be conducted in the jurisdiction where the entity has its principal place of business or chief executive office. For individuals, searches should be performed in the state of the debtor’s residence or where their assets are situated.
Additionally, it may be beneficial to search for pending litigation, not only against the potential borrower, but also against other individuals connected to the transaction, such as officers or members.
6. Bankruptcy Search
The purpose of a federal bankruptcy search is to identify if a prospective borrower has filed for bankruptcy due to an inability to repay their debts. Bankruptcy searches reveal a borrower’s financial distress history to the lender, helping to assess risk.
By understanding a borrower’s financial stability, lenders can make more informed credit decisions and prevent potential losses before approving credit and/or determining the terms.
Where Are Bankruptcy Cases Filed?
Bankruptcy cases for business entities are filed in the federal bankruptcy court located in the debtor’s state of formation, principal place of business or where the primary assets are found. For individuals, cases are typically filed in the federal bankruptcy court of the debtor’s state of residence or where their assets are located.
7. Self-Service UCC Search
Lenders interested in conducting UCC preliminary and name variation searches on their own should consider working with a service provider that offers an online search tool that provides clients the ability to search for UCCs and other liens filed with a central filing office. An individual performing these searches on their own has control over how the searches are conducted and how the results are displayed.
Lenders Love Due Diligence Searches!
And there you have it, 7 types of searches that are important to keep tucked away in a lending due diligence repertoire, because just like anyone else in this season of love, lenders are also out there searching for a sense of security and trust.
This article is provided for informational purposes only and does not constitute legal advice.
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