It Takes Two – A Primer On Structuring EPC/OC Transaction

The Small Business Administration ("SBA") prohibits SBA guaranteed loans being made to passive companies that do not actively use, occupy, or improve the assets acquired with loan proceeds. However, the Standard Operating Procedures ("SOPs") provide an exception commonly known as the Eligible Passive Company ("EPC") rule. The EPC rule must be interpreted strictly, and frequently causes confusion among borrowers and lenders. Through careful analysis of the SOPs and strict adherence to the requirements, parties to the transaction can appropriately structure the transaction in a manner that is in compliance with SBA standards.

An EPC can take any legal form or ownership structure (e.g. corporation, LLC, partnership, individual, etc.), but must only use loan proceeds to acquire or lease, and/or improve or renovate real or personal property that it leases to an eligible operating company ("OC") in order for the OC to operate its business. When structuring an EPC/OC transaction, "an EPC may not use loan proceeds to acquire a business, acquire stock in a business or any intangible asset of a business or to refinance debt that was incurred for those purposes."

As a passive company, the EPC must lease 100% the subject property directly to the OC. Although the OC is permitted to sublease a portion of the property, it must comply with the governing occupancy requirements of the SBA. The lease must be in writing and be subordinated to the SBA's mortgage, deed of trust, or security interest on the real property. When reviewing the lease, the term (including renewal options exercisable solely by the OC) must be greater than or equal to the term of the loan. The rent/lease payments cannot exceed the loan payments to the lender, although the lease may additionally require the OC to cover the EPC's expenses of holding the property, such as insurance, maintenance, and taxes.

The OC must be a co-borrower or guarantor on the loan. If the OC is receiving loan proceeds as working capital and/or for the purchase of other assets, it must be a co-borrower. Each owner of the EPC or OC with 20% or more ownership interest must guarantee the loan. Similarly, if the owner of 20% or more is a trust, the trustee(s) must sign the guarantee(s) on behalf of the trust. If a spouse owns 5% or more of the EPC or OC, he/she must fully guarantee the loan when the combined ownership of both spouses exceeds 20%.

When structuring an EPC/OC transaction, it is important for lenders to understand the details of the EPC rule and note that failure to comply could jeopardize recovery of the SBA guarantee. For more information regarding loan eligibility or other commercial lending matters, please send me an e-mail at soliver@lewis-kappes.com or visit https://goo.gl/2pXbDD.

Chris Poling: cpoling@lewis-kappes.com

Kevin Morrissey: kmorrissey@lewis-kappes.com