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September 6, 2017

Best Practices: SBA Tweaks the EPC/OC Rule

by Victor A. Diaz

Following an extensive review and consideration of public comments, the SBA stands poised to put into effect regulatory changes to the Eligible Passive Rule (“EPC/OC Rule”). Set to become effective on September 20, 2017, after the expiration of the additional, mandatory 30 day period after initial publication, the revisions impact three core principles of the EPC/OC Rule: (i) use of proceeds by the Eligible Passive Company (“EPC”) and Operating Company (“OC”), (ii) required terms of the EPC/OC lease, and (iii) identification of guarantors. The revisions amend regulations affecting all Business Loan Programs, including the 7(a) and 504 Loan Program.

Use of Proceeds

Historically, an EPC had to use loan proceeds only to acquire or lease, and/or improve or renovate, real or personal property it leased to one or more Operating Companies. Consequently, changes of ownership of the EPC itself were not eligible for financing. The strict interpretation mandated by this rule, prevented the financing of changes of ownership between existing owners of the EPC. This limitation threatened the closure of businesses where circumstances required the departure of one of the owners of the EPC and there was no credit elsewhere. The amended regulation now permits the finance a change of ownership between the existing owners of the EPC. Under the 504 Loan Program, loan proceeds may also now be used to finance a change of ownership between existing owners of the EPC, provided any assets owned by the EPC, other than real estate or other eligible long-term assets, and related thereto, are de minimis and are excluded from the 504 Project financing.

With regard to use of proceeds by the OC, the revisions adopt existing principles allowing the OC to use loan proceeds for working capital and/or the purchase of other assets, including intangible assets, for the Operating Company’s use, when the Operating Company is a co-borrower on the loan.

EPC/OC Lease Terms

The revision to the regulation incorporates the long-standing SOP requirement that the rent or lease payments by the OC cannot exceed the amount necessary to make the loan payment to the lender, and an additional amount to cover the EPC’s direct expenses of holding the property, such as maintenance, insurance and property taxes. In the Supplemental Information provided in the publication of the Final Rule, the Agency clarified that for purposes of loans under the 504 Loan Program, “payment to the lender” includes payments to the Permanent Third Party Lender as well as to the CDC. The Agency reiterated its intent not to permit the EPC to profit from its relationship with the OC, but did not address whether a minimum rent payment was required.

Guaranties

Under the existing regulation, each holder of an ownership interest constituting at least 20 percent of the EPC and the OC must guarantee the loan. As amended, the rule will now require each holder of an ownership interest constituting at least 20 percent of either the EPC or the OC to guarantee the loan. Additionally, under the regulation as revised, the SBA, or a lender acting under its delegated authority, may require other appropriate individuals or entities to provide full or limited guarantees of the loan without regard to the percentage of their ownership interests, if any, when deemed necessary for credit or other reasons.

The change in the EPC/OC Rule will have substantial ramifications, particularly those affecting the use of proceeds in changes of ownership and on the ability to require additional guaranties from non-owners or minority owners.  Additional guidance on the revised regulation is expected from the Agency in the upcoming SOP 50 10.  For any further questions, please contact Victor at vdiaz@starfieldsmith.com at 407-618-0694.