Best Practices: Revised Franchise Procedures with the Release of SOP 50 10 5(I)

The Small Business Administration (“SBA”) has released SOP 50 10 5(I), which will take effect on January 1, 2017.  One of the biggest changes in the new SOP relates to the SBA’s franchise procedures, which were modified to incorporate regulatory changes that were put in place on July 27, 2016.  13 CFR §121.301(f)(5) was revised to read as follows:

“Affiliation based on franchise and license agreements.  The restraints imposed on a franchisee or licensee by its franchise or license agreement generally will not be considered in determining whether the franchisor or licensor is affiliated with an applicant franchisee or licensee provided the applicant franchisee or licensee has the right to profit from its efforts and bears the risk of loss commensurate with ownership.  SBA will only consider the franchise or license agreements of the applicant concern.”

So what does that mean for lenders who are extending SBA loans to franchisees (as such term is defined by the Federal Trade Commission in 16 CFR §436 and set forth on page 81 of the new SOP)?

• As of January 1, 2017, SBA will no longer review franchise and license agreements to determine if affiliation exists between the franchisee and franchisor.  SBA will no longer maintain its database of approved franchises known as the Franchise Registry or its listing of franchise fixes known as the SBA Franchise Findings List.  Instead, SBA has issued an SBA Addendum to Franchise Agreement (the “SBA Addendum”) which can be found as an attachment to SBA Policy Notice 5000-1399 set forth at www.naggl.org.  This new SBA Addendum MUST be signed by both the franchisor and franchisee in order for the loan to be eligible for SBA financing.  Moreover, SBA will not accept any alterations to the SBA Addendum.

• If both the franchisor and franchisee sign the SBA Addendum, SBA will not deem the franchisor and franchisee to be affiliated.  But that does not automatically make the loan eligible for SBA financing.  The lender must still determine that the franchisee applicant meets all other SBA eligibility requirements.

• Lenders must review all additional franchise documentation (beyond the Franchise Agreement and SBA Addendum) which the franchisor requires franchisee to sign, in order to determine that such documentation complies with SBA loan program requirements.  Lenders must complete this review and must obtain a fully executed Franchise Agreement and SBA Addendum prior to any loan disbursement.

• Lenders must identify the applicant’s specific franchise in SBA One and/or E-Tran.

• SBA will not consider the franchise or license agreements of affiliates of the applicant, so it is not necessary to obtain the SBA Addendum signed by the applicant’s affiliates.

The new SOP specifically states that (i) failure to identify the franchise in SBA One and/or E-Tran and (ii) obtain the SBA Addendum may result in denial of a lender’s guaranty – so it is imperative for lenders to comply with the new franchise procedures for loans approved on or after January 1, 2017.

See SOP 50 10 5(I) for a full list of the changes to the SBA’s franchise procedures and stay tuned for further clarification as these changes unfold.

For more information, contact Katie at 267-470-1207 or you can email her at kobrien@starfieldsmith.com.