Summary of SBA New SOP 50 10 5(D) Changes
On September 15, 2011, the SBA published its most recent edition of the Lender and Development Company Loan Programs of the U.S. Small Business Administration, SOP 50 10 5(D). Each year, the SBA updates the program to address issues that have arisen over the course of the year. This year’s version focuses on change of ownership, franchises, fee and agents, creditworthiness and life insurance requirements. In addition, there has been a major overhaul of the asset based CAPlines program, which includes working capital and contract CAPlines, and a section on the Community Adjustment and Investment Program. This new SOP 50 10 5(D) is effective October 1, 2011.
Maximum Loan Amounts
The SOP was updated to include the new maximum loan amounts, maximum guaranty amounts and the alternative size standard approved last year, which include the maximum loan amount for a 7(a) loan of $5 million and maximum tangible net worth of applicants can be no more than $15 million with average net income after federal income taxes (excluding carry-over losses) of the applicant for two full fiscal years before the date of application of not more than $5 million.
The SBA Express Loan increased loan limit created under the Jobs Act of $1 million now has expired. SBA Express Loans now are capped at $350,000. To address this issue, the SBA has revised the CAPline program, to provide for up to a $5 million working capital line and allows lenders to use this program in a similar version of its own asset-based lines of credit. Lenders may use their own forms and their own delegated authority (PLP lenders) for this program (there is specific verbiage that must be used in the lender’s forms). This is a welcome revision for the lending community and the hope is that more lenders will use this revised program. The maximum maturity is ten years.
In order to determine the loan amount, lenders may either use their own policies and procedures for similar unguaranteed lines of credit or the SBA’s formula. If the line is based on a borrowing base, then lender must have a first lien on Accounts and Inventory. If no borrowing base is used, the lender must secure the line with sufficient collateral to ensure a 1:1 ratio (unlike a normal 7(a) loan). If the working/trade assets do not provide this ratio, then lender must take additional collateral to meet the ratio requirement, including personal assets. If there is an existing line of credit, it can be refinanced (short-term notes), so long as eligibility requirements for refinance are met (if same institution debt, application must be submitted through the loan guaranty processing center and the SBA may deny guaranty if default occurs within 90 days of initial disbursement). Contract CAPlines finance all costs associated with specific contracts (lenders could not finance overhead costs previously). The contract must permit the lender to obtain an assignment of the proceeds (with some exceptions) and these CAPlines have a ten year maximum term. Under the Contract CAPline program, an applicant may finance multiple contracts (using a master note and subnotes). The lender must retain a first lien in the contract and proceeds (including UCC filing and separate assignment). A lender may take additional collateral if that is the practice in the lender’s unguaranteed contract lines.
Some of the revisions to the SOP are not as welcome. In connection with an EPC/OC structure (where one company owns the real estate and the other company operates the business), the EPC (eligible passive company which owns the real estate) may not use loan proceeds to acquire a business, acquire stock in a business or any intangible assets of a business, or refinance debt that was incurred for those purposes. This new language effectively prohibits the purchase of business where an EPC is involved, as now, only the purchase of fixed assets/working capital can be purchased by the operating company. It is unclear as to whether a lender can structure an asset business purchase involving real estate by splitting the transaction into two separate loans. We are awaiting further clarification from the SBA.
Purchasing a Business vs. Buying Out a Business
In addition, the SBA has clarified what sort of vehicles may be used for the purchase of 100% of a business, and situations where the small business application is attempting to buy out his or her remaining partners. In the first circumstance, where the small business application is purchasing 100% of the business, the applicant may do so either as an asset purchase, and transfer of a partnership interest or the redemption of stock. When a change of ownership is between existing owners, the transfer must be accomplished through either a redemption of stock by the corporation or the transfer of partner’s interest by the partnership. A partner, shareholder or an unrelated third party may not use SBA-guaranteed loan proceeds to purchase an existing owner’s interest in the business. Therefore, stock or partnership purchases are not eligible for SBA financing. Borrowers and sellers should also be mindful of the income tax ramifications of structuring a transaction as a stock redemption vs. an asset transfer. Remaining questions linger. For example, if a corporation redeems the stock of all of the existing owners, then does the corporation reissue stock to new owner? If there are multiple owners, and an redemption increases a prior owner’s interest to over 20% once the redemption takes place, must that minority owner guarantee the loan? Again, we are awaiting further clarification from the SBA.
Debt in Owners’ Names
The SBA now specifically excludes from eligible refinancing any debt in the personal name of the owners (except for credit card debt). It does not matter whether the debt is shown on the borrower’s balance sheet.
The SBA clarified that when a lender desires to use a fixed rate (which may be higher than the maximum rates for variable rate loans but less than the maximum allowable fixed rate), then the fixed rate must remain in effect for the entire loan, without adjustment or reset. Otherwise, the maximum allowable rate for a fix rate loan will be limited to the current maximum allowable rate for variable rate loans (currently 6% to 2.75% over prime). If a lender desires to change the rate after the initial approval, if disbursement has not yet occurred, the lender must obtain the borrower’s written consent. If the rate change is made post disbursement, the change must be based on the method permitted when the loan was approved and be consistent with the interest rate regulations in effect at that time. In either event, the lender must notify the SBA of the change (through E-tran).
Packaging Services Fees
Another area of concern is the changes made regarding fees of packaging and other services. The SBA added a new definition for “packaging services.” Such services relate to assisting an applicant with completing the borrower’s application, preparing a business plan, preparing cash flow projections and preparing other documents related to the application). “Other services” are defined to include consulting as to the type of financing needed and broker or referral fees. A standard fee charged to all borrowers is not acceptable. Also, a lender cannot pass on the lender’s costs associated with the underwriting of the loan, including any services provided by a third party hired by the lender to complete application forms for the lender or prepare the lender’s analysis. Thus, even though a lender may charge the applicant for lender’s completion of applicant’s application forms, it cannot charge the borrower for completing the lender’s application forms. Furthermore, a lender must tell the applicant, in writing, prior to rendering any services, that the applicant is not required to obtain or pay for unwanted services. To satisfy this requirement, lenders should include a statement in their loan applications notifying the applicant in writing that it does not have to use or pay for services and what will be charged if they choose to accept the services.
Extraordinary Servicing Fees
With respect to extraordinary servicing fees, the SOP was clarified to provide that a lender can comply with the prior requirement to obtain written approval of the fee by submitting the amount of the fee and certifying that it is reasonable and prudent based on the level of effort required via E-tran. The SBA will notify the lender if it deems the fee unreasonable, and if so, the lender must refund the fee to the borrower. As a reminder, the amount of the extraordinary servicing fee is limited to the lesser of 2% per year on the portion of the loan requiring extraordinary services (i.e., construction proceeds, borrowing base monitoring) or what the lender charges on similar non-guaranteed loans for the same services. With respect to out-of-pocket expenses, the SOP revisions provide that:
- The lender must itemize the expenses and retain a list in the file for SBA review
- Software costs for loan document preparation cannot be passed on to the applicant
- Lenders are prohibited from passing on charges for work performed by in-house counsel
- Direct costs associated with document preparation (i.e., outside counsel preparing the loan documents) does not require SBA Form 159 reporting.
It now appears that if a lender charges a loan fee on an Express Loan (as a lender is allowed to charge this fee if it charges the same fee on non-guaranteed loans), the SBA must prepare and submit a SBA Form 159 to disclose this fee.
Lender Service Providers
There is also a new section on lender service providers and what can and cannot be accomplished. It is unclear how this new section impacts broker or referral fees paid by lenders, this is being addressed directly with the SBA.
A revision to the franchise section of the SOP places an additional burden on lenders where franchises are involved. Typically, a lender was required to obtain a “certificate of no change” from the franchise to confirm that the approved franchise agreement conforms with the version being used in the transaction. A certification of no material change form is no longer used. Instead, lenders must obtain login credentials for the franchise registry, log in, review the specific franchise eligibility and the effective date of the agreement (if no specific year is listed, a lender shall treat this franchise as if it is not on the registry). The lender must include the executed franchise license/addenda and the executed certification of franchise documents (contained on registry) in its loan file and shall comply with any required eligibility notes. If there are findings, a lender must check the form to see if the negotiated fixes are included in the applicant’s agreement. If not, a lender must verify that the findings are included in the franchise agreement. Lenders must review the franchise disclosure document, any credit information provided (i.e., number of failed franchises and cash flow projections) and include this analysis in its underwriting documentation.
The SOP clarifies what constitutes “leased space” (it may be residential or commercial), however, a borrower cannot use loan proceeds to improve leased space unless, the residential space is occupied by someone needed for the business purpose.
Changes to the credit elsewhere section of the SOP were also made. It adds to the list of persons needing to comply with the “personal resources test” any trustor of a trust. It also confirms that 529 plans (college tuition) are exempt from consideration as liquidated assets and includes liquid assets in revocable trust among the assets to be considered when applying the personal resources test.
Even though life insurance is no longer mandatory under the new SOP and is dependent on the lender’s analysis of active participation in the business, adequacy of collateral, presence of secondary sources of repayment and succession plans, the SOP provides that if there is loss on a loan due to the death of the owner, the lender will be responsible for the loss. However, a lender may now establish escrow accounts for payment of life insurance premiums (by following the same requirements as escrowing for real property taxes) to make sure life insurance premiums are kept up to date.
The SOP clarifies the flood insurance requirements for condominiums and cooperatives. The condominium/cooperative association must maintain flood insurance on the building and the owner must maintain flood insurance on the contents.
The SOP now allows lenders to receive a sales price that exceeds the mortgage balance plus care and preservation expenses or the liquidation value, whichever is less, so long as the SBA guaranty is reduced accordingly.
Eligibility and Prior Loss
The eligibility section has added some additional requirements. A trustor of a trust must now complete SBA Form 912. The SOP revisions also include much more detailed guidance on what constitutes a “prior loss” to the government. Prior loss equals the dollar amount of any deficiency on a federal loan or federally assisted financings that has been incurred and recognized by a federal agency after it has concluded its write-off and/or close out procedures for a particular account, including, a loss on the sale or disposition of collateral acquired after default, compromises where the loan was settled for less than the full amount, bankruptcy by a borrower and/or any guaranties and any unreimbursed advance payment by a federal agency. The amended SOP now includes prohibitions against making a loan to an applicant if there is delinquent federal debt (more than 90 days past due). However, it is not delinquent if the creditor agency has released the obligor, the obligor is subject to or has been discharged in bankruptcy, the obligor is under a written repayment agreement, or the debt is in an administrative or judicial appeal process. The delinquency prohibition exempts unpaid delinquent taxes and losses incurred by the FDIC if the loan is sold at a discount. These provisions apply to any business in which an Associate or Applicant owned, operated or controlled a business that incurred the delinquent debt or caused a prior loss (again the lender must document in the underwriting of the loan that it made this review). A lender may request a waiver of the prohibition regarding delinquent debt from the SBA, and if debt is fully satisfied (as documented by the lender), no waiver is required.
Lender Preference Prohibition and Piggy Back Structure
The prohibition towards lender preference was expanded to add that a lender may not take an additional guaranty (i.e., from a state or local government program) on the unguaranteed portion of the loan without prior SBA approval. In addition, the revised SOP provides that a piggy back structure also exists if there is a companion loan made at the time of the SBA financing for a similar purpose where the SBA has no lien position in certain collateral taken in the non-guaranteed loan (in addition to the prohibition where the SBA has a junior lien position). The SOP did clarify that where the SBA has a senior lien position, there is no piggy back structure.
SBA Loans Approved on a Non-Delegated Basis
A confusing revision to the SOP relates to SBA loans approved on a non-delegated basis. The new SOP provides that the SBA must approve all changes to the Authorization prior to the final disbursement under a loan approved on a non-delegated basis. After final disbursement, a non-delegate lender must send requests to changes in the Authorization to the commercial lending servicing center for approval. This directly contradicts the current SBA servicing matrix. We have been advised that the servicing matrix will be revised with respect to pre-final disbursement and a new SBA notice may go out related to post final disbursement changes (servicing actions), as we have been advised that the SBA did not intend to change the post disbursement servicing actions of non-delegated authority lenders.
The SOP now mandates that all PLP requests for loan numbers (including PLP CAPlines, PLP-EWCP, SBA Express, Export Express and Patriot Express by submitted via E-Tran.
The SOP also added qualification requirements for PLP lenders and additional loans prohibited from PLP processing.
There are also numerous other less controversial revisions to the SOP. A red-line version of the changes to the SOP can be found on the SBA website at www.sba.gov.
There is also a new loan Authorization (9/15/11) that covers 50 10 5(D) changes only; there will be a new version to incorporate the new SOP 50 10 5(D). This version should now be used.
The SBA continually seeks feedback from the lenders on the SOP and the revisions. Lenders should send their comments to SOP501-Modernization@sba.gov. The SBA has advised that the issuance of the SOP 50 51(4) – the combined 7(a) servicing and liquidation SOP is expected to be released around December 21, 2011.
Alison Rind is an attorney at Lerch, Early & Brewer in Bethesda, Maryland. She represents commercial lenders in loan transactions and other commercial matters, including participants in SBA and other government-guaranteed lending programs. For more information about the new SOP, contact Alison at (301) 657-0750 or email@example.com.