(87 FR 64724)

SBA Summary of the Proposed Rule:  The U.S. Small Business Administration (SBA or Agency) is proposing to amend various regulations governing SBA’s 7(a) Loan program and 504 Loan Program, including use of proceeds for partial changes of ownership, lending criteria, loan conditions, reconsiderations, and affiliation standards to expand access to capital to small businesses and drive economic recovery.  The proposed changes to affiliation standards will also apply to the Microloan Program, Intermediary Lending Pilot Program, Surety Bond Guarantee Program and Disaster Loan programs (except for the COVID Economic Injury Disaster Loan (EIDL) Disaster Loan Program).

NAGGL reminds you that these are only proposed changes. The comment period on this Proposed Rule closes on December 27, 2022.  Comments may be submitted through the Federal eRulemaking Portal:  http://www.regulations.gov.  Please refer to the Federal Register publication for more information.

Regulations proposed to be amended – 13 CFR 120 – Business Loan Programs, and 13 CFR 121 – Small Business Size Regulations.  Please read the entire Proposed Rule for additional details.

13 CFR 120 – Business Loan Programs

13 CFR 120.130 – Restrictions on uses of proceeds [see complementary changes to 13 CFR 120.202 – Restrictions on loans for changes of ownership, described below.]

  • SBA is proposing to revise the regulations to remove language prohibiting the use of 7(a) loan proceeds to fund the purchase of a portion of a business or another owner’s interest in a business.

13 CFR 120.150 – What are SBA’s lending criteria?

  • SBA is continuing to require that loan applicants (including any operating companies) must be creditworthy and that loans must be so sound as to reasonably assure repayment ability. But SBA is proposing to remove the detailed list of factors to be considered when determining whether a loan applicant is creditworthy, including removing the requirement that character and reputation be considered.
  • As a substitute for the existing credit analysis factors, SBA is proposing to amend the regulations to require lenders and CDCs to use “appropriate and prudent generally acceptable commercial credit analysis processes and procedures consistent with those used for their similarly-sized, non-SBA guaranteed, commercial loans”. The background information provided as part of the Proposed Rule states that SBA-supervised lenders and CDCs that do not make non-SBA guaranteed commercial loans would continue to underwrite their SBA loans in accordance with the credit policies, including credit scoring models, approved by SBA as part of the lenders’ initial approval for SBA participation and/or during lender oversight processes.
  • SBA also is proposing to add language to the regulations permitting lenders, CDCs and SBA to use a business credit scoring model. According to the background information provided, SBA intends that this model be either the SBA Small Business Scoring Service (SBSS) credit scoring model or another business scoring model. If a non-SBA scoring model is used, lenders and CDCs “must be able to validate the credit scoring model and must document with appropriate statistical methodologies that their credit analysis procedures are predictive of loan performance”. They also must provide the required documentation to SBA whenever requested, including during oversight reviews. Lenders and CDCs would continue to be required to comply with other Loan Program Requirements, such as documenting that credit is not available elsewhere, that the loan meets SBA’s program eligibility requirements, that the uses of proceeds are eligible, and that there are adequate controls on the disbursement of loan proceeds.
  • SBA also is proposing to revise the regulations to state that as part of the lender’s determination of creditworthiness and repayment ability, SBA, lenders, and CDCs may consider (as applicable) three specific criteria:
    1. The credit score or credit history of the applicant (and any operating company), its associates and any guarantors of the loan;
    2. The earnings or cashflow of the applicant; or
    3. Where applicable, any equity or collateral of the applicant.
  • The background information states that the changes would not be intended to prevent lenders, CDCs or SBA “from considering other appropriate factors, particularly if the lenders or CDCs generally acceptable commercial credit analysis processes and procedures for its similarly sized, non-SBA-guaranteed, commercial loans require review of additional factors”. It also indicates that SBA will provide additional guidance regarding creditworthiness and the determination of repayment ability.

13 CFR 120.160 – Loan Conditions

  • SBA is proposing to modify its hazard insurance requirements to state that such insurance would be required only for loans over $150,000.The background information indicates that SBA Loan Program Requirements (presumably, SOP) will state that for loans of $150,000 and less, lenders must follow the hazard insurance requirements that they have established for their similarly sized, non-SBA guaranteed, commercial loans.
  • Per the background information, SBA is not proposing to change the requirements of 13 CFR 120.170 – Flood Insurance.

13 CFR 120.193 – Reconsideration after denial

  • Current regulations require that final reconsideration decisions be made by the Director, Office of Financial Assistance [currently Dianna Seaborn].SBA is proposing to allow such decisions to be made either by the Director or by the Director’s designee(s).For 7(a), the designee would include the Chief, 7(a) Loan Policy [currently Ginger Allen].For 504, the designee would include the Chief, 504 Loan Policy [currently Linda Reilly].
  • SBA also is proposing to provide the SBA Administrator [currently Isabella Casillas Guzman] discretion to review the matter and make the final Agency decision. In such case, the use of such authority would not give rise to any additional appeal rights not otherwise specified in regulation.

13 CFR 120.202 – Restrictions on loans for changes of ownership

  • Currently this section prohibits 7(a) loan proceeds from being used to purchase a portion of a business or a portion of another owner’s interest, and only allows one or more current owners to use loan proceeds to purchase the entire interest of another current owner or a borrower to purchase ownership of the entire business.
  • SBA is proposing to delete the current section and provide new language that would allow a borrower to use 7(a) proceeds to purchase “a portion of or the entirety of an owner’s interest in a business or a partial or full purchase of a business itself”.According to the background information, if this amendment is adopted, SBA intends that a seller be allowed the option of remaining in place as a part owner and employee.

13 CFR 121 – Small Business Size Regulations

13 CFR 121.301 – What size standards and affiliation principals are applicable to financial assistance programs

  • Current size regulations for the financial assistance programs, 13 CFR 121.301(f), include the following criteria for determining that two or more firms are affiliated:
    • Affiliation based on ownership;
    • Affiliation arising under stock options, convertible securities, and agreements to merge;
    • Affiliation based on management;
    • Affiliation based on identity of interest between close relatives; and
    • Affiliation based on franchise and license agreements.
  • SBA is proposing to revise this section to add a new introductory paragraph: “The Small Business Act defines a small business concern as one which is independently owned and operated, and which is not dominant in its field of operation”. It further states: “SBA interprets this statutory definition to require, in certain circumstances, the inclusion of other entities (“Affiliates”) owned by the applicant or an owner of the applicant in determining the size of the applicant”.
  • SBA also is proposing to revise the basis under which affiliation would be found based on ownership. Under the proposal:
    1. When the loan applicant owns more that 50% of another business, the businesses would be considered to be affiliated;
    2. When a business owns more than 50% of an applicant, the businesses would be considered to be affiliated, and if the owner of such business entity also owns more than 50% of another business that operates in the same 3-digit NAICS subsector as the applicant, all of the businesses would be considered to be affiliated;
    3. When an individual owns more than 50% of the applicant and the individual also owns more than 50% of anther business entity that operates in the same 3-digit NAICS subsector as the applicant, the applicant and the individual owner’s other business would be considered to be affiliated;
    4. When the applicant does not have an owner that owns more than 50% of the applicant, if an owner of 20% or more of the applicant is a business that operates in the same 3-digit NAICS subsector as the applicant, the applicant and the owner would be considered to be affiliated;
    5. When the applicant does not have a 50% or more owner, if an owner of 20% or more of the applicant also owns more than 50% of another business entity that operates in the same 3-digit NAICS subsector as the applicant, the applicant and the owner’s other business would be considered to be affiliated;
    6. Ownership interests of spouses and minor children would be required to be combined when determining the amount of ownership interest;
    7. When determining that percentage of ownership that an individual owns in a business, SBA would consider the pro rata beneficial ownership of the entities.
  • The regulations would continue to find affiliation when there are stock options, convertible securities, and agreements to merge. The only change would be deletion of the current introductory sentence in 13 CFR 102.301(f)(2)(iv): “An individual, concern or other entity that controls one or more other concerns cannot use options, convertible securities, or agreements to appear to terminate such control before actually doing so”.
  • SBA is proposing to remove all other criteria under which affiliation currently may be found to exist, including affiliation based on franchise or license agreements.
  • The background information indicates that, if the proposed rule is made final, SBA would cease publication of the SBA Franchise Directory. Lenders would continue to be responsible for ensuring that all applicants meet all Loan Program Requirements. SBA also would continue to collect a franchisor identifier number (currently called Franchise Identifier Code) on each loan based on the list of such numbers available through E-Tran. When the franchise brand is not included in E-Tran, the lender would be required to request a franchisor identifier number from SBA which the Agency would provide without regard to whether the franchise otherwise meets SBA eligibility requirements. Lenders still would be required to consider whether there is affiliation based on ownership. The background information also indicates that SBA would continue to require lenders to determine that a franchise applicant meets all Loan Program Requirements, including, but not limited to, those relating to eligibility and lien priority, and notes that this determination may require a “limited examination” of the franchise, or similar, agreement by the lender.

[Effective May 31, 2022, SBA revised the affiliation regulations governing the Community Advantage (CA) Pilot Program (87 FR 25398, Docket No. SBA-2022-0003).  More details on the changes were provided in the Community Advantage Participant Guide, Appendix G:  CA Affiliation & Franchise Rules, pp. 61-70, and via the following SBA training and resource materials:

SBA has suggested that the information provided in these materials may be helpful to lenders in understanding the regulatory proposals relating to affiliation for the other SBA loan programs.]