Best Practices: SOP 50 10 7.1- Three Key Takeaways

Yesterday the U.S. Small Business Administration (“SBA”) released Standard Operating Procedure 50 10 7.1 (the “SOP”).  The SOP was issued in lieu of the announced but unissued Technical Update to the prior SOP that became effective on August 1, 2023.  Although we will be digesting all of the changes in the SOP in the coming weeks, here are three key takeaways from our preliminary review:

1. SBA Risk Mitigation Platform. Although SBA continues to state that lenders may rely on Applicant’s certifications as to their eligibility and that the loan guaranty will not be repaired or denied if the certification is deemed to be invalid, SBA has added language that calls this into question.  SBA now states that “…in all cases, SBA Lenders must not submit an application that the SBA Lender knows is not eligible, regardless of the Applicant’s certification.”  This raises the question of whether lenders are required to conduct any diligence on any of these eligibility points or not.  This would seem to incentivize lenders to perform less diligence, rather than more on their SBA loan Applicants, which would seem to be contrary to the objectives of a “Risk Mitigation Platform.”  Given this uncertainty, it would be prudent for lenders to continue their existing diligence protocols until further guidance is received.

2. Same Institution Debt Refinance. SBA has clarified its guidance regarding the ability of SBA lenders to refinance their unguaranteed loans under delegated (“PLP”) authority.  While lenders still need to demonstrate a ten percent (10%) improvement to the installment payment amount to be eligible, SBA has also added language citing 13 CFR §120.452, which prohibits lenders from reducing their credit exposure to Applicants using delegated (PLP) authority.  However, this applies to SBA Standard and Small 7(a) loans – lenders can reduce their credit exposure under their SBA Express Authority.

This means that a lender cannot do a straight dollar-for dollar refinance of an unguaranteed loan with an SBA Standard or Small 7(a) loan under its delegated (PLP) authority, as this would reduce the lender’s credit exposure to the Applicant by the guaranty amount.  Accordingly, any such applications must be submitted to SBA for approval under general processing (“GP”).  As to what scenarios would be eligible for SID refinance under delegated processing for Standard or Small 7(a) loans, the SOP offers no additional interpretive guidance.

3. Personal Guarantees. SBA has introduced the concept of “Substitute Guarantors” which would be guarantors that would provide guarantees in lieu of guarantees otherwise required under SBA guidelines (i.e. any 20% or more owner).  SBA requires that the Substitute Guarantor has “similar or greater” value to the guarantor being substituted and requires that a “guaranty liability agreement or transfer agreement” be submitted to the lender and SBA as part of the application package.

At this time, it is unclear under what circumstances would be appropriate for a Substitute Guarantor or when SBA would be comfortable with a lender not obtaining the guarantee of an owner of 20% or more of the Applicant.  This change also leaves open the question of what terms the “guaranty liability agreement or transfer agreement” must contain.  Certainly, questions of consideration for the substitution of guarantee must be considered.  Additionally, questions of whether Substitute Guarantors are subject to or invoke SBA eligibility considerations are unknown at this time.

Additionally, SBA has eliminated the 6-month look-back period which prohibited the reduction of ownership interest within 6 months of application to avoid a personal guarantee.  The elimination of this long-standing requirement provides clarity on how to handle guarantees for partial change of ownership transactions where the seller reduces its ownership percentage below twenty percent (20%).  However, the unintended consequences of allowing changes in ownership up to and including the application date, or even the closing date, are unknown at this time.

We will continue to analyze the changes in the new SOP and will provide analysis and guidance as we receive additional information.  There will also likely be trainings in the near future from NAGGL and NADCO in the near future digesting all of the changes and the considerations that lenders should keep in mind in originating SBA loans under the new guidelines.  For more information regarding the changes to the SOP and SBA compliance generally, contact Ethan at 267-470-1186 or esmith@starfieldsmith.com.