The recipe changes for the SBA alphabet soup – SBA modifies the EPC/OC Rules

On Sept. 20, 2017, the U.S. Small Business Administration (SBA) made certain changes to the notorious Eligible Passive Company rules for Operating Companies (EPC/OC Rules) that govern the disbursement of SBA guaranteed funds to an eligible passive company (EPC). The modified EPC/OC Rules affect the administration of the use of proceeds to an EPC and its related operating company (OC), the terms that must be present in the lease between an EPC and OC, and which owners of an EPC or OC must guaranty the SBA loan.

The first major change to the EPC/OC Rules affects the use of SBA 504 loan program funds in regards to purchases of co-owner interests in the EPC. After modification of the EPC/OC Rules, SBA 504 loan proceeds may now be used by an existing owner(s) of an EPC to purchase the ownership interests of other co-owners of the EPC but only if the use of proceeds related to other assets or property owned by the EPC are de minimus and not part of the 504 loan funding. This extends to EPCs the existing corresponding ability of co-owners of OCs to use 504 loan proceeds for working capital and asset purchases (including membership/stock purchases).

Another change comes in the form of a published comment to the new EPC/OC Rules that reinforces that the rent payment from the OC to the EPC and further amounts necessary to pay expenses related to the subject property such as taxes, insurance, maintenance, etc. cannot exceed an amount necessary for monthly loan payment. The published comment clarifies that as this applies not only to SBA 7(a) loans but also to SBA 504 loans.

The final change implicates which owners of the EPC or OC must guarantee the loan. Prior to the new changes to the EPC/OC Rules, an owner who owned at least 20 percent of the OC and EPC was required to guarantee the loan. As modified, the new EPC/OC Rules require that an owner who owns at least 20 percent of the EPC or OC must guarantee the loan.

The aforementioned changes to the EPC/OC Rules affect both SBA lenders and their attorneys in regards to loan structure, underwriting and diligence review. SBA lenders should consider the modified EPC/OC Rules at all stages of closing to ensure compliance. Further guidance will be memorialized in the upcoming SBA SOP 50 10 5 (J), which is to be effective commencing Jan. 1, 2018. 

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client alert authored by: Evan D. Blewett, Associate

This alert originally appeared in the Winter 2017 Banking Focus newsletter.