As we have discussed over our last few articles, the recent rule changes issued on April 10, 2023 altered the affiliation rules to limit the analysis to issues of common ownership and eliminate the need for lenders to consider matters of control when determining affiliates of a small business applicant. As a part of this change, SBA advised in Procedural Notice 5000-846607 that as of May 11, 2023, it would no longer publish the SBA Franchise Directory. Without the Franchise Directory, lenders are now “responsible for ensuring the Applicant meets Loan Program Requirements.”
In addition to the above, the new SOP 50 10 7 (the “SOP”), which is to become effective on August 1, 2023, strips out all mention of the Franchise Directory. The only references to franchise that remain in the SOP appear in the credit underwriting sections of the SOP. Specifically, the SOP requires lenders to analyze the impact to the credit that a franchise may have, such as the number of failed franchisees or cash flow projections of the franchisor.
While the changes to affiliation set forth in 13 CFR §121.301 and outlined in the procedural notices and SOP are meant to streamline the closing process, the guidance to date has left many lenders wondering what exactly to do with a franchise SBA loan applicant. There does not seem to be any clear guidance addressing how to analyze a franchised small business applicant going forward. Historically, lenders have expressed a level of uncertainty when they didn’t have the Franchise Directory or Franchise Registry to rely upon. Not all lenders feel a level of confidence in their ability to review a franchise agreement or any other related documents, such as an FDD, lease related documents or restrictive covenants for eligibility issues. Without specific guidance from the SBA as to what issues could be an issue at the time of default, many lenders are reluctant to guess as to the SBA’s intentions. In performing franchise reviews, lenders should consider whether the business is an eligible business type the potential impact of these documents on the liens that they intend to take. And lenders must also ensure that no provisions in the documentation would result in the business being deemed ineligible for SBA financing, for example, if it engages in discriminatory hiring practices. Ultimately, lenders must now take responsibility for making these determinations and it is expected that the guaranty will depend upon getting the determination correct.
Furthermore, under SOP 50 10 6, SBA required lenders to obtain executed copies of all franchise agreements, including the Form 2462, prior to disbursement. However, this requirement has been removed from SOP 50 10 7. Will lenders find that this change impacts their or their borrower’s bargaining power in dealings with franchisors? The Form 2462 addendum provisions typically provided some protections to the lender and the franchisee, but franchisors no longer have an incentive to agree to these provisions. If a franchisor determines that it would prefer to wait until a franchisee has secured financing to finalize its deal terms and execute a franchise agreement, will lenders be able to properly protect themselves and the SBA without the regulations to cite to in their negotiations?
Since it is the lender that is responsible for ensuring an applicant meets all loan program requirements, lenders should tread lightly and document their loan files to set forth what analysis they have undertaken to determine whether a particular franchise is eligible.
If you are a lender with questions on a franchise loan applicant, feel free to reach out to Lyndsay Rowland at email@example.com or 215-542-7070.