What a Due Diligence Search Can Do For You

March 26, 2019 by Alexandra N. Anast, Esq. Alexa P. Stephenson, Esq.

A borrower files bankruptcy or files a lawsuit against you. It’s every lender’s worst nightmare. What can lenders, loan servicers, and/or other secured creditors do to avoid the dreaded litigation headache? In an ideal world, lenders would be able to actually stop their borrower from filing bankruptcy or a lawsuit once, let alone multiple times. However, unfortunately there is nothing lenders can legally do today to prevent their borrower from doing so. Given the ease of filing bankruptcy and lawsuits in California, the majority of borrowers who are faced with foreclosure will attempt to delay or halt the sale by taking action in the state or bankruptcy courts.

So how can you avoid those problem borrowers? To determine whether a specific borrower will cause a litigation or bankruptcy headache later on, we recommend conducting a thorough investigation of the proposed borrower during the origination process; otherwise known as a due diligence search.

A borrower seeking a loan is not likely to volunteer information that would give a reasonable lender cause for concern. As such, a due diligence report is a valuable resource to glean information about the prospective borrower that was not included in a loan application, but is extremely relevant to the lender’s ultimate decision of whether to fund the loan.  For example, a good due diligence search will show you:

  • The borrower’s assets;
  • The borrower’s professional licenses;
  • The borrower’s corporate records and business registrations;
  • The borrower’s debts (including UCC filings, deeds of trust/mortgages, liens, and judgments);
  • The borrower’s real properties which were subject to non-judicial foreclosure proceedings;
  • The borrower’s prior lawsuits;
  • The borrower’s prior bankruptcy filings;
  • The borrower’s criminal record;
  • The borrower’s arrest record; and
  • The borrower’s OFAC listings (if any).

While a due diligence report can help uncover facts which were not previously disclosed by the borrower, it can also test the veracity of a borrower’s claims about his business, his experience, and his intentions with regard to requested loan funds.  For example, your borrower might have applied for a non-owner-occupied loan, but a due diligence report reveals that the property to secure your loan has been the borrower’s primary residence for the last five years. What if the due diligence report also reveals that the borrower has filed suit against previous lenders for wrongful foreclosure and multiple bankruptcy petitions? This information should make you or your investor reconsider funding the loan to that borrower, or at least change the terms of the loan agreement to protect against the extra risk.

In another example, a due diligence report will include search results for any federal or state  lawsuits in which the borrower was a named party. This will show you if the borrower has demonstrated a pattern of suing its lenders, partners, contractors, funds control managers, or other parties with whom it does business. In the alternative, a borrower may have been sued by others. Lawsuits against a borrower are particularly concerning where the nature of the suits relate to fraud, breach of contract, etc. Although a borrower will not make a point to advise you of their litigation history, it is essential to consider whether a borrower is likely to sue you or cause you to be sued by a third party.

Putting it all together: A due diligence report, particularly during the early stages of loan origination, is an invaluable resource.  You may discover some skeletons in the borrower’s closet, or you might not. Either way, a due diligence search empowers you to make confident decisions about with whom you do business.

If you are a lender, loan servicer, or secured creditor, and you have a question about a potential borrower or want to order a background check, contact the Geraci Law Firm today.  We are happy to give you a free initial consultation on your potential problem borrower.