June 3, 2015

Best Practices: Beware Brokers or Dealers Masquerading as Franchisees

by Starfield & Smith

The SBA requires lenders to analyze several different types of borrower contracts for affiliation.  The species of contracts include franchise agreements, license agreements, dealer agreements, jobber (fuel supply) agreements and any similar type of contract.  Lenders need to exercise caution in performing this analysis.  The SBA has found affiliation in some unexpected places when reviewing broker and dealer agreements.

Even though the term “franchise” has legal significance outside of SOP 50 10 5 (H), the SBA uses the term “franchise” in the SOP as a shorthand for all types of contracts subject to the affiliation analysis.  One of the ways the SOP determines that affiliation exists is where the “franchisor” exercises excessive “control” over the “franchisee.”  A large portion of the SOP franchise discussion is dedicated to ferreting out instances where “control” creates affiliation.

The SOP provides several examples of contractual terms that suggest excessive control over the borrower/ franchisee.  The examples, however, are mainly applicable to actual franchise agreements.  The examples are not as helpful in the context of broker or dealer agreements that are subject to the same “franchise” analysis under the SOP.  The general lack of broker-specific or dealer-specific guidance leads to varying interpretations of “control” by the SBA.

Lenders should be particularly careful where the borrower acts as a broker for services actually performed by the “franchisor” and where the borrower essentially acts as an outside salesperson for finished goods manufactured by the “franchisor.”

The SOP states that there is no affiliation between an insurance broker/borrower and the insurance company, even if the brokered policies are owned by the insurer and the insurer collects the premium payments directly.  Those SOP provisions, however, are only applicable in the insurance industry.  The SBA could find affiliation in broker agreements that function in the same way but are not in the insurance industry.  Just because insurance brokers are safe does not mean that other types of brokers are safe, even if they operate in exactly the same way.

The affiliation issue gets even murkier where the borrower sells finished products manufactured by the “franchisor.”  The issue of whether affiliation exists in this context generally turns on the borrower’s product concentration.  If the borrower’s entire business is reselling finished products for a single manufacturer, the SBA likely will find affiliation.  The issue is cloudier where the products being resold by the borrower constitute a smaller percentage of the borrower’s business.  The SBA examines these on a case-by-case basis and therefore does not specify a specific maximum percentage that is safe.

If a lender has any doubt about whether affiliation exists, we strongly encourage the lender to seek guidance from counsel or directly from the SBA.  Since these issues relate to borrower eligibility, a lender could face a denial of its SBA guaranty if it does not adequately assess the potential affiliation issues and the loan goes into liquidation.  The safest course is to obtain an opinion from the SBA prior to closing, rather than risk facing a worst case outcome in the guaranty purchase process.

For more information regarding SBA affiliation analysis, please contact Greg at or at 215-390-1023.