Best Practices: Further Changes to Franchise Review Procedures Under SBA Policy Notice 5000-1941

In a previous Starfield & Smith article posted on December 14, 2016, I discussed SBA’s new franchise guidelines that were implemented with SOP 50 10 5(I) in an effort to streamline the franchise review process for lenders. Since the posting of that article, SBA has issued Policy Notice 5000-1941 (the “Policy Notice”), effective February 14, 2017, which made further changes (some only temporary) and clarifications to the process.

Lenders can now either (i) obtain the updated SBA Addendum to Franchise Agreement (SBA Form 2462, which is discussed below) OR (ii) obtain an SBA Negotiated Addendum in conjunction with the Certification. This second option is only a temporary option and SBA has not given any guidance as to how long this option will be permitted. But for the time being, lenders are permitted to obtain an SBA Negotiated Addendum, which is an addendum that was developed by SBA and the franchisor in connection with either a 2015 or 2016 version of the franchise agreement in question and which is listed on the Franchise Registry. If lender goes this route, it will also need to obtain the Certification/Form 2463 signed by the franchisor. Such Certification requires the franchisor to certify to the following items:

• SBA previously reviewed the franchise agreement (either a 2015 or 2016 version) and determined that the franchise agreement along with the SBA Negotiated Addendum did not create any affiliation between franchisor and franchisee;
• the terms of the borrower’s franchise agreement, as such terms relate to affiliation, have not changed from the agreement that SBA reviewed; and
• the borrower’s franchise agreement includes the SBA Negotiated Addendum.

The other option is for lenders to obtain the SBA Addendum to Franchise Agreement, which can be found here.

This addendum was previously required for franchise loans approved after January 1, 2017, but the Addendum was updated as of February 14, 2017 to incorporate the following changes:

• includes a drop down box to address relationships other than franchisor/franchisee (e.g. jobber, licensor) and to define the “franchise” agreement differently for jobber agreements, license agreements, etc. – this should alleviate some of the issues that lenders were facing in getting jobbers and licensors to execute the previous version of the SBA Addendum to Franchise Agreement;
• clarifies that franchisor restrictions that have been recorded against the franchisee’s real estate must be removed in order for the franchisee to obtain an SBA loan;
• clarifies that for temporary personnel franchises, the temporary employees will be employed by the franchisee rather than the franchisor;
• the SBA Addendum to Franchise Agreement now terminates when SBA no longer has any interest in any SBA financing with the borrower/franchisee – this allows the SBA Addendum to Franchise Agreement to be used for multiple loans to the same borrower; and
• the signature blocks now include language stating that the individuals signing the SBA Addendum to Franchise Agreement are authorized to do so and such individuals acknowledge that submission of false information to SBA or withholding information from SBA can result in criminal prosecution.

The Policy Notice also gives guidance regarding borrowers with several types of agreements used in the operation of the business. SBA will only require review of those agreements that are “critical” to the borrower’s business. SBA deems agreements to be critical when they (or the products, services or trademarks covered by the agreements) account, either individually, or in the aggregate with borrower’s other agreements, for at least 67% of the borrower’s revenues. If the agreement is considered critical under this definition, lenders must obtain either the SBA Addendum to Franchise Agreement or an SBA Negotiated Addendum and Certification.

Lenders must still obtain (i) copies of the franchise agreement, (ii) the SBA Addendum to Franchise Agreement or an SBA Negotiated Addendum and Certification and (iii) all other franchise documents that franchisee is required to execute, and such fully executed documents must be obtained prior to disbursement. Although lenders can rest assured that the franchisor and franchisee are not affiliated if lenders follow all of SBA’s guidelines and obtain the appropriate documentation, lenders must still review the agreements to ensure compliance with all other SBA loan program requirements, such as eligibility, credit concerns and collateral concerns.

If the SBA Addendum is not executed prior to loan approval, the following language must be inserted into the Loan Authorization: “Lender must obtain the executed Franchise Agreement, either (i) the SBA Addendum to Franchise Agreement (SBA Form 2462), or (ii) the Certification (SBA Form 2463) and SBA Negotiated Addendum, and all other documents the franchisor requires the franchisee to sign prior to any disbursement of Loan proceeds and retain in the loan file. Failure to obtain the executed documents may result in a denial of liability on the guaranty.”

Stay tuned as the franchise review process continues to evolve. For more information, please contact Katie at 267-470-1207 or at kobrien@starfieldsmith.com.