SBA Issues Additional Guidance on Affiliation Rules

In connection with the relief being offered to small businesses as a result of the impact of COVID-19, the CARES Act has modified certain provisions of the Small Business Administration’s (“SBA”) size and affiliation regulations to expand accessibility to qualified applicants.

Typically, in order to be eligible for an SBA loan, the size of the applicant’s business (based on either the number of employees or annual receipts) determines eligibility.  Absent  a specific exception, in determining whether or not a business concern meets the SBA’s maximum size requirements, an applicant must  include the number of employees or annual revenue of any of its affiliates.  Applicants that operate under an agreement meeting the Federal Trade Commission definition of a franchise are subject to further requirements than those businesses which do not.  Specifically, if a business is a franchise, the franchise itself must be listed on the SBA Franchise Directory in order to be eligible.

In an effort to permit greater access to the financial assistance under the CARES Act, and specifically under the Paycheck Protection Program (“PPP”), Congress has modified the SBA’s size and affiliation requirements as follows:

  1. If an applicant owns multiple businesses in the Accommodation and Food Services industry (these are businesses with a NAICS Code beginning with 72), the applicant is eligible to request a loan under the CARES Act provided that there are not more than 500 employees at any physical location.
  2. The SBA’s affiliation rules do not apply to the following business concerns: (a) any business that has no  more than 500 employees and is classified in the Accommodation and Food Services industry, (b) any business that is being operated pursuant to a franchise agreement, and the franchise has a franchise identifier code on the SBA Franchise Directory;  or (c) any business that receives financial assistance from a company licensed under Section 301 of the Small Business Investment Act.

Except as noted above, the SBA’s affiliation rules will continue to apply to businesses seeking financial assistance under the CARES Act.  To provide further clarification, the SBA recently released a supplemental Interim Final Rule (“Rule”) addressing the application of SBA affiliation rules in the context of the PPP. This Rule expands upon the SBA Interim Final Rule released on April 2, 2020 (“Initial Rule”), which proposed preliminary guidelines with respect to administration and application of the PPP.

Below is summary of the recent guidance the SBA provided on the application of the affiliation rules:

  1. SBA Affiliation Rule.
  • Ownership: A person or entity is deemed an affiliate if such person or entity owns or controls more than 50% of the voting stock of a business concern. Where the voting stock of a business is widely held, or in the event that no person or entity is found to control, the Board of Directors or Chief Executive Officer or President (or such other person(s) who control management) are deemed to have control. A minority shareholder will be deemed to be in control if such shareholder has the ability to prevent a quorum or block action by the board of directors or shareholders.
  • Unvested Rights: For purposes of determining size, the SBA treats all stock options, convertible securities and agreements to merge (including agreements in principle) as fully vested and/or exercised.  Note that “agreements in principle” do not include agreements to continue negotiations.  Options, convertible securities and agreements that are subject to conditions precedent that are speculative, conjectural, unenforceable under applicable law, incapable of fulfillment or where the probability of the transaction (or exercise of the rights) occurring is shown to be extremely remote, are each not considered vested/effective.
  • Management: A person or entity is deemed an affiliate if the Chief Executive Officer or President of the applicant (or other officers, directors, managing members or general partners vested with management authority) also controls the management of one or more additional businesses. Affiliation is also applicable if the same person or entity controls the Board of Directors or management of more than one business concern or if the same person or entity controls the management of the applicant through a management agreement.
  • Identity of Interest. The SBA can also determine that affiliation exists when there is an identity of interest between “close relatives” with identical or substantially identical business or economic interests.  The example given by the SBA is where the “close relatives” operate businesses in the same of similar industry in the same geographic area.
  1. Exemption for Faith Based Organizations.
    • The Rule provides an exemption for otherwise qualified faith-based organizations from SBA affiliation rules, citing authority under the Religious Freedom Restoration Act which prohibits the imposition of substantial burdens on religious exercise. The Rule aims to preserve eligibility for religious organizations that would otherwise qualify for relief under the CARES Act but for their affiliation with other entities as an aspect of their overall religious practice. To that end, the SBA affiliation rules do not apply to “the relationship of any church, convention or association of churches, or other faith-based organization or entity to any other person, group, organization or entity that is based on sincere religious teaching or belief or otherwise constitutes a part of the exercise of religion,” including parent/subsidiary relationships and other organizational structures.

We are continuing to monitor as additional guidance is released by the SBA and will provide new Alerts as appropriate.  Our attorneys are available to answer any questions and assist with PPP applications.

As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice. For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.

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