Best Practices: What SOP 50 10(7) Does Not Tell Us

Over the past few weeks we have discussed many of the changes in the SOP 50 10 (7).  Now that it is in effect, and as we wait for the pending technical update from SBA, it’s worth pointing out what is not in the new SOP compared to SOPs of the past, and how the deletion of certain language may impact SBA lenders.  Some of these changes are obvious, and others you might not realize are missing unless you are looking for them.

The first and most obvious change is the removal of Part I to the SOP which covered all participation requirements for 7(a) Lenders and CDCs in the 7(a) and 504 programs, respectively.  This guidance is now addressed in a new SOP 50 56.

Another significant change is removal of the guidance on Character Determinations, which previously required broadly looking back at an applicant’s complete criminal history, but now only requires an inquiry into whether any Associate (officers, directors, 20% or more owners, key employees, or equivalent) is currently incarcerated, on probation, on parole, or is under indictment for a felony or any crime involving or relating to financial misconduct or a false statement.  However, the relaxation of this requirement does not excuse lenders from following any internal or regulatory requirements they may otherwise be subject to, such as determining Beneficial Ownership and BSA/AML/KYC compliance.

In a previous article we discussed the removal of the requirement for reviewing for affiliation by Management, Franchise, License, Dealer and Jobber Agreements.  The practical effect of no longer being able to rely on the Franchise Directory and SBA Addendum 2462 for determinations of affiliation and eligibility is that SBA lenders must take a closer look at these agreements and perform their own eligibility analysis.  Management agreements could render Borrowers passive (businesses that do not actively use or occupy the assets acquired or improved with the loan proceeds).  Additionally, a Franchisor’s security interests in personal property, collateral assignment of leases or ability to take over operations without notice may cause a franchisee to default on their SBA loan and impact the SBA lender’s ability to recover collateral.   With the new affiliation rules, SBA lenders are discovering that franchisors are frequently not amenable to negotiating certain business terms with individual lenders when not subject to SBA’s written requirements and oversight, and that the review process is costly and cumbersome.  As a result, some SBA lenders may determine that going forward financing franchises may not be attractive targets to include in their SBA loan portfolios.

On the SBA Connect Call in July, SBA stated that occupancy guidance on leased locations would be added back in a technical update, but currently there is no guidance in SOP 50 10 (7).  Specifically, the new SOP does not include the definition of Rentable Property, which is used to determine whether minimum occupancy requirements are met.  The SOP also does not currently address the need for an assignment of lease, landlord waiver, or provide any guidance for  ground leases.  Regardless of whether a technical update is issued to add back these concepts, the absence of this language does not necessarily remove these requirements for most SBA loans. Not only has SBA stated that SBA lenders must “do what they do” for similarly sized non-SBA loans, but it also holds SBA lenders to a prudent lending standard.   Being unable to access and sell equipment because there is no landlord waiver, or not having access to condemnation proceeds on a leasehold deed of trust, may impact an SBA lenders ability to make a meaningful recovery and have a corresponding impact on the SBA guaranty.

This same prudent lending standard applies to many other areas that have been streamlined by removing specific guidance in the new SOP, such as: (i) documenting debt refinance, (ii) defining and sourcing equity injection, (iii) requiring insurance other than hazard insurance, such as liability, worker’s comp., or malpractice insurance, and/or (iv) setting minimum construction requirements standards for 7(a) Loans. These are just a sampling of some of the provisions that have been modified in the new SOP to remove prior specific requirements, but not necessarily remove the prudent lending compliance obligation for SBA lenders.   It is critical for SBA lenders to read the new SOP to not only better understand the new rules, but also to consider what guidance is no longer included, and set their institutions’ own credit and closing policies in this new SBA lending landscape.

For more information, or assistance with updating your SBA lending policies and procedures, please reach out to Kimberly Rayer at krayer@starfieldsmith.com.