The Small Business Administration ("SBA") recently released SOP 50 10 5(I), which supersedes SOP 50 10 5(H), and took effect on January 1, 2017. One of the most significant changes involves the SBA's franchise procedures, which were modified to incorporate regulatory amendments adopted on July 27, 2016. The new regulatory provision, 13 CFR §121.301(f)(5), reads as follows:
"Affiliation based on franchise and license agreements. The restraints imposed on a franchisee or licensee by its franchise or license agreement generally will not be considered in determining whether the franchisor or licensor is affiliated with an applicant franchisee or licensee provided the applicant franchisee or licensee has the right to profit from its efforts and bears the risk of loss commensurate with ownership. SBA will only consider the franchise or license agreements of the applicant concern."
The changes apply to "franchisees" as defined by the Federal Trade Commission in 16 CFR §436 and provided for on page 81 of the new SOP. The SBA describes the changes as "significant improvements in policy and process that will reduce time and costs." Although the changes help streamline the process, the new requirements must be strictly followed in order to prevent potential denial of lender's guarantee.
Below are some highlights for lenders in light of the new franchise procedures:
- The SBA will not review individual franchise/license agreements to determine whether there is affiliation between the franchisee and franchisor. Due to this change, there will no longer be a Franchise Registry. Instead, the SBA mandates that lenders obtain an Addendum to Franchise Agreement ("Addendum") which can be found at https://goo.gl/Cky6Te. This requirement is loan specific and is not satisfied if the franchisor has executed an Addendum in connection with another loan. The Addendum must be signed by both the franchisor and franchisee in order for the loan to be eligible and cannot be altered.
- If the Addendum is signed by both franchisor and franchisee, the SBA requirement that the franchisor and franchisee not be affiliated will be satisfied. However, the Addendum only addresses "affiliation" between the franchisee and franchisor. It does not automatically make the loan eligible for SBA financing. The lender must still determine that the applicant meets all other eligibility requirements.
- The lender must not disburse any loan proceeds without: (i) a fully executed Franchise Agreement; (ii) a fully executed SBA Addendum to Franchise Agreement; and (3) proper review of all other documents the franchisor requires the franchisee to sign in order to comply with SBA loan program requirements. The Franchise Agreement, SBA Addendum to the Franchise Agreement, and all other documents the franchisor requires the franchisee to execute must be submitted with any request for the SBA to honor the guarantee.
- The lender must identify a franchise loan before entering the application into E-Tran or SBA One.
- The SBA will not consider the franchise/license agreements of the applicant's affiliates. The Addendum only requires the signatures of the franchisee and franchisor of concern.
- The SBA added a new provision for analyzing collateral when dealing with a franchise/license transaction. The lender must consider "the impact that covenants and other restrictions recorded against the collateral may have on its value and marketability."
The new SOP mandates that lenders adhere to the franchise procedures. If a lender fails to identify the franchise in E-Tran/SBA One or to obtain the SBA Addendum, it could result in denial of its guaranty. As SBA lending continues its growth trend into 2017, lenders must be vigilant of the SOP changes and always stick to prudent practices.
Lewis Kappes proudly represents lenders and banks involved in SBA financing, as well as other commercial lending matters. For more information about SOP 50 10 5(I), or to speak with one of our attorneys, please contact: