If you’ve read our previous posts in this series, you’re probably convinced that you should have some sort of strategy for keeping aware of federal tax liens that get placed on clients in your portfolio—but what? In this post, we provide a few “best practice” tips.

Currency is king

You already have a ticking clock over your head once a federal tax lien is filed on one of your clients. Don’t speed up the clock by relying on data that lags behind the times. Information culled from online databases is inexpensive, but you get what you pay for. It’s not current. In fact, it often lags months behind real-time data. By the time you find evidence of a lien filing, you have likely already issued credit that will be second in priority to the IRS.

Instead, get your data straight from the source. Hire a service provider to do manual searches at the state and county level, which means sending someone physically to the clerk’s office. This is the surest and most effective method of detecting federal tax and other liens quickly and effectively. With this kind of data currency, if there’s a tax lien, you’ll find it in time to act.

State or county?

There are a number of jurisdictions that require federal tax liens to be filed only at the county—not state—level. So, in these jurisdictions, if the database or service provider you are using is relying on state data, then you will never find that lien at all. For this reason, county data is an imperative.

How often to search?

The next question is how frequently you should be searching. The answer really depends on your comfort with risk, but decisions can be made on a deal-by-deal basis, based on the value of the deal or the risk profile of the borrower. If you want the most comprehensive protection, you should perform state and county-level manual searches every 30 days. If you decide a particular deal is lower risk, you may want to search every 60 days, or quarterly.

The bottom line

We recommend that you conduct what is known as “recurring searches” at the state and county level. This recurring due diligence will be essential to protecting your interests throughout the lives of your loans; you’ll be alerted with immediacy to events such as federal tax liens that can threaten your portfolio, so you can take appropriate action to protect yourself. You decide how frequently you want to search, on a deal-by-deal basis. A service provider can help you perform the searches, and some service providers, such as CT Lien Solutions, manage the process and the results. For more information on the benefits of conducting recurring due diligence with CT Lien Solutions with our innovative new technology and trusted service teams, click here.

In the last post we discussed why you should care about staying alerted to federal tax liens, and we mentioned the 45-day time limit lenders are faced with in the unlucky (but somewhat likely) instance of the IRS placing a federal tax lien on one of your clients. You’ve probably heard of the 45-day rule before—but how well do you understand it? Let’s look at an example scenario.

The Internal Revenue Code (IRC) provides for certain situations in which a lender may retain priority over a federal tax lien, where the federal tax lien was filed after the lender entered into a security agreement with the borrower. Can you recognize which of the four loans described below allow for the lender to retain first position over the IRS?

Facts

• ABC Factor enters into a security agreement with XYZ Retailer, with the debtor’s accounts receivable secured as collateral. The UCC is filed on January 15, 2012. ABC makes a loan of $15,000 on that date.
• The IRS files a federal tax lien on XYZ Retailer on February 6, 2012.
• On March 3, 2012, ABC Factor makes a loan of $5,000 to XYZ Retailer. ABC has no knowledge on this date of the aforementioned federal tax lien.
• On March 4, 2012, ABC Factor learns of the federal tax lien.
• On March 5, 2012, ABC Factor loans XYZ Retailer $2,000.
• On May 31, 2012, ABC Factor loans XYZ Retailer $1,000.

So, quiz time. Who has priority on a) the $15k loan; b) the $5k loan; c) the $2k loan; and d) the $1k loan? Answers below:

• The loan made on January 15, 2012 for $15,000 has priority over the federal tax lien. The agreement was entered into and the loan was made before the federal tax lien was filed.
• The loan made on March 3, 2012 for $5,000 has priority over the federal tax lien. It is in compliance with the IRC Section 6323(c)(2) because lender and borrower entered into the loan in the ordinary course of businesses; the agreement was entered into before the federal tax lien was filed; at the time of the loan, the lender had not received knowledge of the existence of the federal tax lien; and the loan was made within 45 days of the filing of the federal tax lien.
• The federal tax lien has priority over the loan made on March 5, 2012 for $2,000, because the bank had actual knowledge of the existence of the federal tax lien at the time it made the loan. Because of this knowledge, the 45-day time limit does not apply. ABC should not have extended credit to XYZ after learning of existence of the federal tax lien.
• The federal tax lien has priority over the loan made on May 31, 2012 for $1,000, because the bank had actual knowledge of the existence of the federal tax lien, and the loan was made after the 45th day of the filing of the federal tax lien.

Note also (and this is important!) that in the above scenario, if ABC Factor never learned of the existence of the federal tax lien, any loans made to XYZ after the 45th day following the federal tax lien would still have been second in priority to the IRS. As we mentioned in our previous post, the onus is on the lender to be aware of federal tax liens, whatever it takes.

So what does it take to stay aware? Read on.

Implications to due diligence best practices

It is recommended that you search for federal tax liens before issuing any new credit (including new loans in revolving lines of credit) to any borrower, especially those of high-risk. Practically speaking, this is often best achieved by setting a recurring search schedule of, for example, every 30 or 60 days.

Because lenders must discontinue all new funding immediately upon becoming aware of the federal tax lien, you’ll want to use a carefully managed process for conducting these searches and reviewing their findings. Choose a service provider such as CT Lien Solutions that provides you with clear, concise search results that direct your attention precisely and with immediacy to the presence of any existing federal tax liens, so that you can take immediate action.

For more tips on developing a trusted recurring due diligence strategy, read the final post in this series tomorrow.

So, you’ve done your initial due diligence and approved a client for a revolving line of credit secured by assets such as inventory or accounts receivables. You file a UCC and begin extending loans, and everything seems to be going smoothly, until you get wind of the infamous “f” word…federal tax lien, filed on your client! If you’re hearing about this as a result of routine, recurring due diligence, chances are you’re in an excellent position to mitigate your risk. If you’re not searching for federal tax liens routinely, your lien position and ability to recoup your investment may already be lost.

Why should you be concerned about federal tax liens? The short answer is because they may take priority over loans made in revolving lines of credit, and you ultimately may not be able to recover your investment. Let’s begin to examine why and how.

First, consider that you are issuing revolving lines of credits to your clients over a period of time—and, these clients are typically high-risk borrowers. They’ve checked out in the initial due diligence phase, but what about events that may happen during the life of the loan? Specifically, how confident are you that a client is paying its federal taxes on time? Should the IRS file a federal tax lien against your client (we’re assuming you already have a perfected UCC filing on the record), you have only 45 days from the date of this IRS filing (or until the date you become aware of the federal tax lien, the earlier of the two—more on this in tomorrow’s post) to take appropriate action to protect yourself, including halting any new extensions of credit. The onus is on you to find out that the tax lien was filed. My guess is your client is not going to tell you, and the IRS is notoriously remiss in notifying lenders (as appointees of the 8821 form) that a lien was filed.

But let me give the IRS the benefit of the doubt (hey, it’s almost tax season…I don’t want any bad blood between us); let’s assume they do provide notice. Have you received it in time? If you have extended any credit to your client beyond the 45th day after the federal tax lien was filed, it is second in priority to the IRS. Should the matter go to collections, the IRS will be entitled to claim its share of the pie first, and you’ll be left hoping for any crumbs left over.

The 45-day rule is a little more complicated then this, and bears further examination. We’ll cover it in more detail tomorrow.

Then, on Thursday, we’ll explore best practices for developing a due diligence strategy that will maximize your protection against risk from federal tax liens and other threats. Because of the uncertainty of receiving notice of federal tax liens from your clients or from the IRS, it is always best to develop a strategy to proactively search for federal tax liens, so you’re not left guessing whether they might exist.

This week in New York, the Commercial Finance Association hosts its 67th Annual Convention, geared toward professionals in the asset-based lending, factoring and related industries. CT Lien Solutions is excited to once again be sponsoring and exhibiting at the event. If you’re attending, stop by and see us at Booth #502 in the Exhibit Hall!

To read the Annual Conference issue of the CFA’s Secured Lender magazine, click here. This issue includes our five tips to help ABLs and factors proactively protect against threats to their position, as well as our advice on secured lending best practices should a state government shutdown affect the availability of Secretary of State services.

For more information on the Commercial Finance Association, including its Secured Lender publication, visit www.cfa.com.