Even experienced commercial lenders can encounter problems when seemingly minor details in a loan approval or closing process receive less attention than they deserve. Outdated approvals, errors in commitment letters, incomplete due diligence, documentation gaps, UCC perfection and priority issues, and deficient payoff letters can all lead to delays, additional expense, or unintended risk. This article highlights several common pitfalls in commercial loan approval and documentation and offers practical steps lenders can take to identify these issues early and help ensure a smoother closing and stronger loan documentation.

Commercial lenders and their counsel routinely navigate complex commercial lending transactions and the regulatory, compliance, underwriting, and documentation requirements that accompany them. Yet, even in sophisticated lending organizations, the basics can sometimes be overlooked. In the rush to close a transaction—and while appropriately focusing on regulatory requirements, underwriting issues, and other complex matters—seemingly simple details in the loan approval, commitment letter, due diligence process, or closing documents can receive less attention than they deserve. These oversights can create significant problems, delays, and unnecessary expense, whether before, during, or after closing. This article highlights several common, but often overlooked, issues in commercial loan approval and documentation and offers practical steps lenders can take to help avoid them.

Failing to Update a Loan Approval

Errors in loan approvals sometimes find their way into loan documents. To help avoid this, keep loan approvals accurate, current, and complete in accordance with the institution’s policies and procedures. As a transaction evolves, one or more modifications to the loan approval may be necessary to change, supplement, or delete terms and conditions. For example, a lender should not submit a request for approval of a floating rate of Prime plus 2.50% while continuing to refer to an erroneous fixed rate in the analysis section of the approval package.

Mistakes in Commitment Letter

Lenders should carefully review the commitment letter and understand applicable regulatory requirements, institutional policies, and underwriting guidelines before drafting it. Many institutions have scrutinized their form of commitment letter with the assistance of outside counsel, yet fail to engage counsel to make deal-specific changes when needed. Commitment letters often contain a variety of conditions a borrower must satisfy, as well as various “outs” available to the lender. Despite such lender protections, many borrowers remain focused on “getting the loan,” and some may still pursue litigation in an effort to compel funding.

A commitment letter should be clear and unambiguous.

Common mistakes include:

• Specifying the wrong borrower (this can occur because of punctuation or spelling errors or simply selecting the wrong entity, as sometimes happens when dealing with affiliates).

• Incorrect terms and conditions (loan amount, interest rate, maturity date, and similar provisions).

• Failing to clearly define terms placed in quotation marks.

• Failing to properly reference a separate fee letter or confidentiality agreement.

• Omitting proper expiration or termination provisions.

One additional area that warrants special attention—because it has been mishandled in the commitment letter—is the type, amount, and treatment of fees and expenses, including those of the lender, its legal counsel, and third parties. The treatment of required deposits with the lender has likewise been mishandled at times.

A commitment letter should be clear as to the treatment of such items. For example, the letter should clearly describe and distinguish among a due diligence fee, a good-faith deposit, and a commitment fee. It should also specify what these fees, payments, deposits, and other items will cover, including when and how they will be applied, and whether all or any portion will be refundable and under what circumstances. Legal counsel can assist with precise drafting of these provisions.

Not Gathering Important Information Early in the Process

Waiting until the last week or day before closing to obtain reports and other necessary checklist items will most likely delay the closing and can become a significant source of frustration for all parties. Third-party vendors are typically not as motivated as the lender or the borrower and may not prioritize the transaction. Therefore, any third-party reports—such as UCC and judgment searches, appraisals, title reports, engineering reports, surveys, or environmental reports—should be ordered early to avoid delays and to allow adequate time for review.

In addition, certain information contained in these reports may need to be addressed or incorporated into the loan documents, which can require additional negotiation and drafting time. Examples include pending lawsuits against the borrower, collateral issues such as undisclosed or unauthorized liens and encumbrances, subordination and intercreditor issues, landlord consents, and property-condition matters.

Unacceptable, Missing, or Incomplete Commercial Loan Documents

Many lenders have encountered unacceptable, missing, or incomplete loan documents, as well as issues with specific terms and conditions, that have caused problems and delays. This can occur whether the documents are prepared internally or with the assistance of outside counsel.

Common mistakes include:

• Failure to document the loan in accordance with the loan approval. A focused line-by-line comparison can help avoid this.

• Not preparing a thorough transaction checklist that identifies all applicable borrowers, guarantors, grantors, pledgors, security documents, and other requirements. Lenders often overlook certain nested entities within a borrower or grantor group, raising an important practical question: How far should the lender's due diligence extend?

• Not incorporating standard terms and provisions into commercial loan documents as and when required under the lender’s loan-documentation guidelines (which are typically prepared by its legal department). Such guidelines may require specific definitions and provisions pertaining to Prime, SOFR, or other applicable benchmark rates, prepayment penalties, yield maintenance, swap transactions, financial covenants, and related items.

• Failure to include appropriate execution formalities, including notary acknowledgments where required by law, the nature of the document, or the lender's policies.

• Extensive negotiation of draft loan documents with the borrower or its counsel, resulting in numerous revisions and multiple drafts. This process can create inconsistencies and other anomalies within or among the loan documents and, if not carefully controlled, can inadvertently weaken or impair the lender's rights and remedies.

• Not including waiver or release-of-claims provisions when documenting modifications or renewals, as advised by legal counsel and as warranted by the circumstances of the loan.

Lack of Perfection and Priority Issues

Additional steps may be required to perfect a security interest and establish or preserve the secured party’s priority against competing claimants. This process is known as “perfection.” Quite often it does not occur as it should, leaving lenders inadvertently subordinate to other creditors and, in some cases, unsecured.

Common examples include:

• Debtor-name errors, particularly those resulting from incorrect debtor names on Uniform Commercial Code (UCC) financing statements. Careful attention to the statutory debtor-name rules is critical, particularly those set forth in UCC § 9-503. Separately, for a security interest to attach, the debtor generally must have rights in the collateral or the power to transfer rights in the collateral to a secured party, and the other requirements of UCC § 9-203(b) must be satisfied. Thus, real property held in an Illinois land trust, for example, should not automatically be treated as collateral of the beneficiary merely because the beneficiary holds the beneficial interest in the land trust.

• Improper or missing grantors or pledgors of collateral. If the lender is also taking a security interest in a land trust beneficiary’s own personal-property interests, for example, including the beneficiary’s interest in the land trust, the beneficiary should execute the appropriate security agreement and assignment, as applicable, and the lender should ensure that any required financing statement properly identifies the beneficiary in that capacity [1]. Under Illinois law, the beneficiary's interest in an Illinois land trust is personal property and is distinct from the real property held by the trustee. This is particularly important where the beneficiary owns or controls collateral or contractual rights are being pledged, such as when the beneficiary is identified as the landlord under leases, receives or controls rents, or is providing separate covenants to the lender. If the beneficiary is the party that holds the relevant lease or rent rights, obtaining an assignment from the beneficiary can provide important additional contractual and collateral protection.

• Lack of perfection involving certificated securities, negotiable documents, or instruments. Section 9-312(e) of the Illinois Uniform Commercial Code provides that a security interest in certificated securities, negotiable documents, or instruments is perfected without filing or the taking of possession or control for a period of 20 days from the time it attaches to the extent that it arises for new value given under an authenticated security agreement. This temporary-perfection rule can be particularly important in lending transactions involving collateral that the secured party expects to receive but does not receive within the 20-day period. If the secured party does not take the steps otherwise required to maintain perfection before the 20-day period expires, the temporary perfection terminates. Importantly, Illinois UCC §9-312(a) expressly permits perfection by filing for instruments and negotiable documents, among other types of collateral. Thus, for instruments and negotiable documents, filing may provide an alternative means of perfection if the lender does not obtain possession within the 20-day period. The Illinois amendments to the Uniform Commercial Code that became effective January 1, 2025—including the adoption of Article 12 governing controllable electronic records and related amendments to Article 9—did not eliminate or alter this 20-day temporary-perfection rule applicable to certificated securities, negotiable documents, and instruments.

Deficient Payoff Letters

Deficient payoff letters can be problematic. Lenders should obtain all necessary payoff information and corresponding release documentation from parties claiming a lien on the collateral that will secure the new loan, so that the lender’s lien position is consistent with the loan approval.

Common mistakes include:

• Release language set forth in the payoff letter (apart from any separate release documents) that is not sufficiently broad or appropriately tailored. For example, the lender should confirm that no collateral securing the new loan will continue to secure an existing loan from another lender through cross-collateralization or otherwise.

• Absence of “further assurance” language requiring an existing lender to cooperate with the new lender. This is particularly important when the existing lender is required to deliver possessory collateral, execute releases or termination documents, or otherwise cooperate in transferring or perfecting the new lender's lien.

• Failure to establish a clear mechanism for filing termination statements. The payoff documentation should specify who is responsible for obtaining and filing the required termination statements and, where appropriate, should include the existing secured party's authorization or other documentation necessary to facilitate the filing.

• Absence of reliance language permitting the new lender to rely on the provisions of the payoff letter (particularly if the letter is not addressed to the new lender).

• Failing to include a provision stating that the payoff letter will not be modified without the prior written consent of the new lender.

This article is not intended to be exhaustive; it is a summary of some significant challenges facing lenders. Careful planning and awareness of these issues may improve the quality of loan approvals and commercial loan documents, as well as the closing process, helping to fulfill the expectations of both lenders and borrowers.

If you have any questions about this article, please contact: Samuel L. Pappas, Esq.

The foregoing is intended to be marketing material. Information is contained in this article is for general education and knowledge. It is not designed to be and should not be substituted for legal advice. This information is not intended to create an attorney-client relationship.

[1]  Current Illinois § 9-310(b)(8) expressly provides that filing is otherwise unnecessary for a beneficial interest in an Illinois land trust that is perfected by control under § 9-314.