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October 4, 2017

Best Practices: Management Agreement Affiliation Determinations

by Ethan W. Smith

Over the last several years, the use of “Management Agreements” has become a much more common method by which small businesses are choosing to run their businesses. In industries as diverse as hospitality, self-storage, and even professional services, the use of management agreements has become commonplace. However, the use of a management agreement for a small business applying for a SBA loan can present eligibility challenges for SBA lenders.

In SBA’s revisions to its affiliation rules, which took effect on July 27, 2016, SBA enunciated affiliation rules specific to its loan programs at 13 CFR §121.301(f). One clarification contained in this rule change was in regard to affiliation based on common management between two small businesses. Much of the rule remained unchanged, confirming that businesses that were under common management, or whose management was under common control, were affiliates. The SBA then went on to add that: “Affiliation also arises where a single individual, concern or entity controls the management of the applicant concern through a management agreement.” 13 CFR §121.301(f)(3). In its comment to the new rule, SBA indicated that “Details on the types of management agreements that result in determinations of affiliation will be provided in Loan Program Requirements.”

Although at the time of this article, the SBA has not finalized written guidelines governing Management Agreements and when they create affiliation, SBA officials have offered guidance on the criteria governing the affiliation determination in such circumstances by looking to a decision of the SBA Office of Hearings and Appeals from 1997. This case involved a management agreement executed by a medical practice with a local hospital whereby the hospital would provide all of the administrative and non-medical aspects of the business operations for a fee. The court focused on the following criteria in rendering its decision that the management agreement did not create affiliation between the small business and the management company:

  • The small business and the management company were in different businesses;
  • The small business and the management company had no common ownership;
  • The small business maintained control over, responsibility for, and the ability to exercise independent judgment over the performance of its core business and primary product/service/task;
  • The small business retained the ability to set and approve its prices;
  • The management company only had limited access to the small businesses bank accounts, for the sole purpose of carrying out the agreement; and
  • The term of the management agreement was limited and not indefinite.

Lenders should be mindful that these criteria are not exhaustive and are generated from a decision related to a specific set of facts. There may be provisions of other management agreements that could push the decision one way or the other on a case by case basis. However, the case is instructive as to the types of factors that the SBA has considered in the past, and may consider in the future in assessing affiliation based on management agreements. SBA lenders that are evaluating loans to borrowers that are using management agreements should be careful of the potential affiliation and eligibility issues involved and take reasonable steps to ensure that such agreements are carefully evaluated to ensure eligibility.

For more information regarding SBA affiliation determinations for management agreements, contact Ethan at 267-470-1186 or via email at esmith@starfieldsmith.com.