SBA Digest: Temporary Changes to the Franchise Review Process

Brief Overview Of Changes To The Franchise Review Process

The U.S. Small Business Administration ("SBA") recently announced temporary changes to the franchise review process for 7(a) and 504 loan programs. These changes improve the review process for franchise agreements pursuant to SOP 50 10 5(I). As described in more detail below, the changes temporarily allow lenders to submit a certification from the franchisor together with a previously negotiated addendum ("Negotiated Addendum") in lieu of the Addendum to Franchise Agreement ("Universal Addendum") that is required under the current SOP. Furthermore, the SBA revised the Universal Addendum to include agreements other than "franchise agreements" (e.g., dealer, license, and jobber agreements).

Effective on February 14, 2017, the SBA will accept the following to establish that a franchisee is not "affiliated" with a franchisor: (1) the revised Universal Addendum (SBA Form 2462); or (2) a Certification (SBA Form 2463) together with the franchisor's previously Negotiated Addendum. If pursuing the latter option, the previously Negotiated Addendum must be from a 2015 or 2016 version of a franchise agreement negotiated between the SBA and franchisor.

History Of The Franchise Review Process

A business must be "small" in order to be eligible for SBA financing. The Small Business Act defines a small business as "one which is independently owned and operated and which is not dominant in its field of operation." 15 U.S.C. § 632. There are instances when a business is considered small, despite not being independently owned and operated. If a business is "affiliated" with another business, the SBA will consider, among other things, the number of employees with the business, receipts, and other measures of size to determine whether the business is small.

If a business operates under a franchise agreement, the SBA will find affiliation between a franchisee and franchisor if the franchisee does not have the right to profit or bear the risk of loss associated with business ownership. 13 CFR § 121.301(f)(5). Through years of analyzing the factors that impact these criteria, the SBA pinpointed aspects that indicate affiliation between a franchisor and franchisee. To resolve the issues associated with affiliation, the SBA created an addendum for use in connection with SBA loans. This addendum, which is referred to as a "Negotiated Addendum" throughout this article, when executed, eliminated the finding of affiliation.

On November 22, 2016, the SBA issued SOP 50 10 5(I), which subsequently went into effect on January 1, 2017. The new SOP adopted the Universal Addendum for transactions where the agreement meets the Federal Trade Commission (FTC) definition of a franchise in 16 CFR § 436. The Universal Addendum replaced the Negotiated Addendum for purposes of finding no affiliation between franchisors and franchisees.

The new notice, effective February 14, 2017, revises and clarifies the current process for lenders submitting franchise loans to the SBA.

Revisions and Clarifications

1. Alternative to the Universal Addendum

The Universal Addendum replaced the Negotiated Addendum on January 1, 2017. Now, the SBA is temporarily revising the current policy to permit an alternative to the Universal Addendum: a Certification (SBA Form 2463) by the franchisor coupled with the previously Negotiated Addendum. The Negotiated Addendum must be from either a 2015 or 2016 version of a franchise agreement negotiated between the SBA and franchisor. If the addendum does not fall within this timeline, the alternative is invalid and the lender must obtain the revised Universal Addendum in conformance with SOP 50 10 5(i).

2. Revisions to the Universal Addendum

After release of SOP 50 10 5(i), the Universal Addendum received commentary regarding use of terms such as "franchise agreement," "franchisor," and "franchisee," when the document is required for other agreements (e.g., dealer, license, and jobber agreements). The SBA also identified clarity issues and implemented the following revisions:

  • a. The Universal Addendum now allows the entity to select the appropriate type of agreement and titles of the parties to each agreement. For example, an entity can now select franchise, license, or jobber agreement and appropriately title the parties to the agreement. The Universal Addendum also permits parties to manually insert labels for other types of agreements and specifically name the entity, rather than labeling it as "franchisor."
  • b. The language under the "Covenants" heading now speaks to any restrictions that might be recorded against the franchisee's real estate. If restrictions are present, they must be removed from title. Otherwise, the franchisee is ineligible for SBA financing.
  • c. The language under "Employment" heading now clarifies that employees will be employed by the franchisee, not the franchisor, in temporary personnel franchises.

The temporary changes help improve the review process for franchise, license, dealer, jobber, and other similar agreements. Additionally, the revisions to the Universal Addendum help clarify issues and provide banks and lenders with a better understanding of the SBA's intent.

Lewis Kappes proudly represents lenders and banks involved in SBA financing, as well as other commercial lending matters. For more information regarding changes to the franchise review process, please contact:

Chris Poling: cpoling@lewis-kappes.com
Kevin Morrissey: kmorrissey@lewis-kappes.com
Scott Oliver: soliver@lewis-kappes.com