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At its most basic, a lien is “the right to keep possession of property belonging to another person until a debt owed by that person is repaid.”
A lien guarantees that a creditor is in line to receive payment should a borrower default or file bankruptcy. It is generally secured by collateral, and that collateral is often the property being financed. In practical application, this means that a lien gives a lender the right to, for example, repossess financed office equipment when a borrower falls behind on payments. (There are also “blanket liens” where a creditor files a general lien against all of a borrower’s assets.)
Sometimes a business or certain property belonging to that business is subject to multiple liens. In that case, the lienholder who filed first is generally paid back first, with subsequent lienholders paid back in the order in which they filed the lien.
Knowing whether or not a potential customer is subject to a lien is crucial for business-to-business (B2B) onboarding, such as making informed underwriting decisions about a potential borrower.
A lien could be attached to a business for a number of reasons, but there are three types:
When making a credit risk decision, it’s important for lenders and other financial institutions to know whether potential borrowers are subject to any liens.
But first, they must find out if a customer has a lien on their property. And this can be harder than it sounds. While liens are a matter of public record, they aren’t always easy to find. Next we’ll cover the most common places to look for a lien on a potential business customer.
In the US, states get to make their own laws and regulations. But some things, including liens, transcend state lines. The Uniform Commercial Code (UCC) is a set of laws meant to help states create similar laws when it comes to things like liens.
When a lender has a claim to a piece of property, they file a UCC-1 Financing Statement with the Secretary of State in the borrowing business’s home state. (This wasn’t always the case. Keep reading for more reasons why liens can be hard to find.) This serves as public notice that the lender can lay claim to that property should the borrower fail to pay back the debt.
A UCC lien filing includes the name of the borrower, the name of the creditor/lien holder, and information about what property the lien covers. These lien filings are a matter of public record and can be found via a search in a state’s Secretary of State database.
The federal government files a federal tax lien against a person or business who neglects or fails to pay a tax debt.
Not only does a federal tax lien attach to a taxpayer’s personal property, it attaches to their business property. Should the tax debt remain unpaid, a federal tax lien allows the government to seize assets, including business property and accounts receivable for businesses. A federal tax lien isn’t necessarily discharged in bankruptcy, either. Each individual state can also levy a tax lien against a delinquent taxpayer.
The traditional way analysts sought out potential liens was inconvenient and time consuming. Liens are generally held at the state level, meaning there are multiple databases in which to search for liens. Worse, it only recently became best practice to file a lien in a borrower’s home state. This means that a borrower based in Delaware might actually have liens filed in California and Massachusetts or any number of other states.
With Middesk’s Underwriting solution, we first verify the business’s identity. After all, it would be no fair if “Bobbie’s Donuts” was denied a loan because of liens placed on “Bobby’s Doughnuts.”
Next, we connect with databases where liens are stored to return liens (if any) that are attached to that particular business. Using Middesk’s modern API, we search the UCC filing system and the IRS’s federal tax lien database, then return that information in an easy to read format so you can make an informed underwriting decision. This means no more sifting through expired liens or liens attached to the wrong company.
It depends. A lien you discover through a UCC filing may not necessarily be a negative. Perhaps your business customer financed sixty standing desks for their office. It’s standard practice for the lender to file a lien using the standing desks as collateral until the loan is paid back. That lien will exist even if the borrower makes every payment on time and is in completely good standing with the lender. In this case, a different lender may be comfortable extending credit to that same business owner.
But, in the case of a UCC lien, you’ll want to examine what property the lien covers. If your customer is refinancing a piece of factory equipment, you’ll want to ensure that no other lender already has a lien on that same piece of equipment. Otherwise, you’ll be in second place to receive your money back should the buyer fail to repay or file bankruptcy. The same goes for any blank liens that lenders file against all of the borrower’s assets.
A tax lien (or statutory lien) is potentially riskier. A federal or state tax lien means that a borrower owes taxes to a government entity. In the worst case scenario, this demonstrates that the potential borrower is in financial trouble. After all, the government always gets their money first.
However, not all tax liens are risky. While a lien may be present, it may be for a small amount of money. Your lending risk model may allow a loan to a customer with a $400 tax lien, but reject a potential borrower with a tax lien of tens of thousands of dollars.