Best Practices: When to obtain an Attorney Opinion Letter to Confirm 401(k)/ROBS Plan Qualification

A business owned in whole or in part by a 401(k) plan — including a Rollover as Business Startup (ROBS) plan — may be eligible for an U.S. Small Business Administration (SBA) loan, provided the lender complies with SBA’s requirements and the plan itself complies with all applicable IRS, Treasury, and Department of Labor rules. SBA is explicit that it will not review any application — even one submitted through non-delegated processing — for compliance with the requirements imposed by those other regulatory bodies. That responsibility falls entirely on the lender.

To meet that responsibility, the SBA lender must:

• Identify the specific type of 401(k) plan (Single Employer, Multiple Employer, etc.) in E-Tran and credit memorandum and note if a ROBS plan is being used and for what purpose;
• Obtain the full, unconditional guaranty of the 401(k) plan sponsor(s), regardless of their individual ownership interest, which guaranty should be secured if required by SBA’s collateral policy; and
• Collect required plan documentation, including:
  • A favorable IRS determination letter which provides assurance that the 401(k) plan satisfies qualification requirements
  • For an existing plan, the Annual Return/Report of Employee Benefit Plan (e.g., IRS Form 5500, IRS Form 5500-EZ, etc.)
  • For a ROBS plan: C-corporation formation documents, 401(k) plan adoption documents, stock purchase documents, and related corporate resolutions
• Obtain the borrower’s certification, prior to disbursement of loan proceeds, that the borrower and the 401(k) plan are in compliance with all applicable IRS, Treasury, and Department of Labor requirements and that it will comply with all relevant operating and reporting requirements.

Finally, the loan cannot be structured as an EPC/OC and SBA loan proceeds may not be used for any 401(k) plan formation costs.

The Gap in the IRS Determination Letter:

On its face, the requirement for an IRS determination letter appears to be straightforward, however documentation of this due diligence item is more nuanced.  The lender has two (2) options for compliance:

1. Individually designed plan: The borrower submits its own specific 401(k) plan directly to the IRS, and the IRS issues a determination letter confirming that the specific plan is a “qualified” plan. Here, the lender can rely on the IRS letter itself as confirmation of compliance with qualification requirements.
2. Prototype plan: An intermediary submits a prototype 401(k) plan to the IRS and receives an IRS determination letter confirming the prototype plan is a “qualified” plan.  The borrower, thereafter, “adopts” the prototype plan by signing an adoption agreement, or the borrower uses the prototype plan form(s) to establish its own 401(k) plan.  In this instance, the lender should not rely on the IRS letter itself as confirmation of compliance with qualification requirements.

Close the Gap with an Attorney Opinion Letter: 

In order to bridge the gap left by the prototype plan option set forth above, a lender should obtain an opinion letter from an attorney for the intermediary.  The attorney opinion letter should be addressed to the lender and confirm that the borrower’s 401(k) plan is substantially the same as the prototype plan and is, therefore, a qualified plan that is exempt from providing a guaranty for the SBA loan. Without the attorney opinion letter, the lender cannot comply with SBA’s requirement that the lender confirm the plan meets the requirements and conditions prescribed by the IRS, Treasury, and Department of Labor.

The Bottom Line:

In order to remain SBA compliant, it is critical for a lender to understand that an IRS determination letter alone is sufficient only when the borrower’s specific plan was submitted to and approved by the IRS, and a lender should supplement an IRS determination letter approving a prototype plan with an attorney opinion letter addressed to the lender.

For further guidance in SBA compliance and loan closing matters, please contact the attorneys at Starfield & Smith, PC at (215) 542-7070 or visit us at www.starfieldsmith.com.