Mitigating risk is a key component of lending, and it requires you to learn as much as possible about a potential borrower. Whether they’re an individual or business, you need to know the value of their assets, cash flow, credit score, and — most importantly — existing liabilities. Discovering this requires an aggressive approach to due diligence, which includes performing Uniform Commercial Code (UCC) lien, federal and state tax lien, and pending litigation searches — what’s referred to as a four-part search.
By identifying all claims against the party, you can calculate the value of their assets and the likelihood of repayment if they default or file for bankruptcy. Ultimately, you gain the information you need to decide whether to lend to them and on what terms, or to walk away from a risky transaction.
Part 1: UCC lien search
A UCC lien is a public notice that a party obtained a business loan and allowed the creditor to take a security interest in certain business property. A lender files a UCC-1 statement with the Secretary of State (SOS) where the borrower is incorporated or the records office where the collateral — which could be inventory, equipment, real property, vehicles, or investments — is located. The lien could be against specific collateral, or it could be a blanket lien against numerous assets.
As part of due diligence, you would perform a UCC lien search with the SOS where the borrower is incorporated or where the property is located. You must have the debtor’s correct legal name for an accurate search. A UCC lien, which lasts for five years before the secured party must renew or continue it, demonstrates that the lender takes priority over other potential creditors in the event of default or bankruptcy. You might uncover numerous secured creditors. More than one business can file a UCC lien; their UCC statement submission dates determine their priority ranking.
You must determine whether another party would have priority over your secured interest. The more creditors ahead of you in line, the less likely you are to recover your investment. Also, several UCC statements attached to a business or property gives you an idea into the debtor’s financial stability and value of their assets.
Consensual vs. non-consensual liens
Property owners can agree to liens, or various legal authorities can place holds on assets without their consent. A UCC lien is consensual because a party agrees to a creditor placing a claim on one or more assets in exchange for a loan. However, federal, state, and local tax liens, as well as judgment liens, are non-consensual because they don’t require the debtor’s permission.
The distinction matters — borrowers might not be aware of non-consensual claims, and they can’t disclose what they don’t know. Unknown interests are a particular concern for mid-sized to large businesses that have gone through mergers, acquisitions, and other changes over the years — officers might not be aware of liens against the business’s assets. Rigorous due diligence, which requires more than a UCC lien search, enables you to find out about non-consensual liens the party either failed to tell you about or didn’t know about themselves.
Part 2: Federal tax lien search
The Internal Revenue Service (IRS) can place a claim on all real estate, personal property, or other assets if an owner fails to pay federal taxes. It’s imperative that you determine if a potential borrower has a federal tax lien. Numerous laws give IRS liens precedence over other creditors — even if they filed UCC liens and perfected their interests. Another concern is that tax liens follow the property. Obtaining a secured interest in a piece of property means you also acquired that lien.
Identifying federal tax liens is complicated due to the IRS recording liens through local authorities. You need to perform lien searches in specific jurisdictions, which means you need to be aware of any relevant locations to the debtor and variances in their legal or business name.
Part 3: State tax lien search
State and local governments also place liens on property if residents fail to pay income and property taxes, and these claims can win priority over a creditor with a perfected interest in an asset. Federal, state, and local tax liens are just as concerning — if not more — than UCC liens. If you find a tax lien, the government will likely receive payment first in the event of the borrower’s bankruptcy or default.
State and local tax lien searches face the same troubles as a federal tax lien search. You might need to search several jurisdictions and consider variances in the debtor’s name to uncover relevant security interests. The process is burdensome enough that it benefits you to work with a third party whose core competencies include public record searches.
Part 4: Judgment lien search
Individuals and businesses can become creditors by winning lawsuits against other parties. Whether through a breach of contract or personal injury case, a victorious plaintiff can place a hold on the defendant’s assets to attempt to satisfy the judgment. You need to be on the lookout not only for current judgments but also for potential verdicts against a prospective debtor. Due diligence requires searching for ongoing litigation, during which a judge or jury could decide against them, altering their financial position and potentially, your interest.
Unearthing judgment liens and pending cases can be challenging compared to finding a UCC lien. Litigation can arise anywhere, including outside of the borrower’s location. It helps to perform litigation searches at the federal, state, and county levels — including bankruptcy courts.
Let Lien Solutions handle four-part searches
Due diligence necessitates looking for numerous types of liens and is a cumbersome process. You have to consider various jurisdictions, the debtor’s legal last name or business name, common misspellings, and any previous names. We offer lien management services for every stage of the lending process. We perform all types of UCC, tax, and judgment lien searches on your behalf, ensuring you have a thorough understanding of a prospective borrower’s debts and your potential priority before finalizing terms and closing a loan.