Best Practices: Affiliation Based Upon Identity of Interest

SBA lending, with its myriad rules, regulations and ever-changing guidelines, has always been a challenge for compliance-minded lenders.  One of the most difficult SBA topics for lenders to deal with has been affiliation, with its multiple ways for businesses to be deemed affiliated with one another.  Although complex, the rules concerning affiliation are usually somewhat intuitive from their titles: for example, affiliation based upon common ownership, common management, franchise agreements and the like, generally give the reader an idea of what the grounds for determining affiliation will be.  But what about an “Identity of Interest”?

SBA’s loan program rules regarding affiliation based upon an “Identity of Interest” state that affiliation arises from an Identity of Interest when:

“…there is an identity of interest between close relatives…[a spouse, a parent, or a child or sibling, or the spouse of any such person]… with identical or substantially identical business or economic interests (such as where the close relatives operate concerns in the same or similar industry in the same geographic area).”  13 CFR § 121.301(f)(4).

Therefore, in addition to examining other entities in which the principal of a loan applicant may have an ownership interest, or may be an officer or director of, Lenders must be cognizant of the fact that family members that are in the same or similar business as the applicant may need to be considered by the lender when determining whether the applicant meets the SBA’s size-standard requirements, and whether such potentially affiliated businesses have utilized some or all of the SBA financing that might be available under the program.

The Borrower’s SBA application (SBA Form 1919) provides some guidance for loan applicants by restating the SBA rules regarding affiliation and asking a series of questions to the applicant as to whether affiliation exists.  Likewise, the Lender’s application (SBA Form 1920) also seeks certain representation and analysis of any affiliates of the applicant.  The difficulty with relying upon these forms is that an affiliation analysis is often a difficult and nuanced determination for a borrower, or a lender, or even an attorney, to make.

In a recent ruling from its Office of Hearings and Appeals, SBA summarized the identity of interest standard:

“[SBA] has extensive case precedent interpreting …[ the Identity of Interest] regulation as creating a rebuttable presumption that close family members have identical interests and must be treated as one person. … The presumption arises, not from the degree of family members’ involvement in each other’s business affairs but, rather, from the family relationship itself. … Generally, a finding of affiliation based on familial relationship is a rebuttable presumption and can be overcome by establishing a clear line of fracture between the individuals.”  Size Appeal Of: Zlynx Enterprises, Inc., SBA No. SIZ-6010, 2019 (S.B.A.), 2019 WL 2499323 (emphasis added).

This guidance from SBA is helpful for lenders because it confirms that the affiliation arises from the familial relationship, and not from the degree of involvement that they may have in each others’ businesses.  Unless there is clear evidence of a fracture in the relationship, the presumption of affiliation will likely control.

Lenders should ensure that they have a clear picture not only of the businesses that are owned or controlled by the principals of their applicant business, but also of the businesses owned or controlled by the close relatives of these individuals.  Only by conducting a thorough affiliation analysis of an applicant can SBA lenders ensure that the businesses that they are lending to are, in fact, small and that they are not overextending SBA guaranty dollars above the program caps.  Failure to perform a correct and comprehensive analysis can potentially jeopardize the SBA guaranty.

For more information regarding SBA affiliation analyses, contact Ethan at 267-470-1186 or esmith@starfieldsmith.com or visit us at www.starfieldsmith.com.