Since the SBA’s Paycheck Protection Program went into effect last Friday, there has been considerable confusion about eligibility and, in particular, what affiliation rules apply to program applicants. The affiliation rules are important for helping companies determine if they can seek out these important loans.
In this post, we’ll let you know which affiliation rules apply to the program’s applicants and explain some exceptions to the applicable affiliation rules.
The Paycheck Protection Program is generally open to entities with 500 employees or less, including employees of all affiliates. As discussed below, SBA’s rules determine whether an entity has affiliates.
Which affiliation rules apply?
If you are familiar with small business size standards and affiliation issues (which we discuss a lot on this blog), you are probably also familiar with SBA’s rules at 13 C.F.R. § 121.103. That’s great! But these rules are not the standards applicable to Paycheck Protection Program applicants. Instead, it’s actually the rules found at 13 C.F.R. § 121.301 that apply.
“For applicants in SBA’s Business Loan, Disaster Loan, and Surety Bond Guarantee Programs, the size standards and bases for affiliation are set forth in § 121.301.” 13 C.F.R. § 121.103(a)(8). The SBA also confirmed that “applicants in SBA’s Business Loan Programs (which include the PPP) are subject to the affiliation rule contained in 13 CFR 121.301” in its PPP Affiliation Interim Final Rule.
What are the affiliation standards under 13 C.F.R. § 121.301 and how are they different from § 121.103?
Under § 121.301’s affiliation standards, “[c]oncerns and entities are affiliates of each other when one controls or has the power to control the other, or a third party or parties controls or has the power to control both.” In addition,”[i]t does not matter whether control is exercised, so long as the power to control exists.” As under the affiliation rules at § 121.103, control is key.
Section 121.301(f) highlights six general bases for finding affiliation: common ownership; potential control under stock options, convertible securities, or agreements to merge; common management; identity of interest; the newly organized concern rule; and totality of the circumstances.
Many of these bases for affiliation are similar to the affiliation rules under § 121.103. But, overall, an affiliation finding under § 121.301 may be less likely for a few reasons.
For one, there is a smaller risk that a minority owner could lead to an affiliation finding under § 121.301. Under § 121.103(c), where there is no majority owner and two or more minority owners are equal or approximately equal in size, and combined the minority owners are large as compared with any other stock holding, SBA presumes that each such minority owner controls the concern whose size is at issue. A similar rule would apply if there is one owner with less than 50% who owns substantially more than the next highest owner.
By contrast, under § 121.301, if no one “individual, concern, or entity . . . owns or has the power to control more than 50 percent of the concern’s voting equity,” the SBA “will deem the Board of Directors or President or Chief Executive Officer (CEO) (or other officers, managing members, or partners who control the management of the concern) to be in control of the concern.” Minority shareholders, in contrast to the rule at 121.103, may only be found to control where they can “prevent a quorum or otherwise block action by the board of directors or shareholders.”
In addition, § 121.301 has distinctly different rules for affiliation based on the newly organized concern rule. As we discussed here, SBA may find affiliation under the § 121.103 version of the newly organized concern rule for a number of reasons. The § 121.301 version of the rule, however, is much narrower. For instance, affiliation can only arise where “there are direct monetary benefits flowing from the new concern to the original concern”–language not found in § 121.103.
This is not a complete list of differences between the two affiliation standards, but it covers two of the major ones. There is also one major similarity to note: both standards apply to the affiliation exceptions found at 13 C.F.R. § 121.103(b).
Are there any exceptions to applying 13 C.F.R. § 121.301?
Yes! There are three general groups to which 13 C.F.R. § 121.103 and 13 C.F.R. § 121.301 don’t apply. Because the CARES Act enacted a waiver of § 121.103 for these three groups, § 121.301 does not apply to them either. They are:
- “[A]ny business concern with not more than 500 employees that, as of the date on which the loan is disbursed, is assigned a North American Industry Classification System code beginning with 72.” NAICS codes starting with 72 are applicable to “Accommodation and Food Services” including businesses like hotels, restaurants, bars, caterers, and related services.
- “[A]ny business concern operating as a franchise that is assigned a franchise identifier code by the [Small Business] Administration.”
- “[A]ny business concern that receives financial assistance from a company licensed under section 301 of the Small Business Investment Act of 1958 (15 U.S.C. 681).”
Though not exempt from affiliation considerations under the CARES Act waiver, faith-based organizations might not be affiliated with one another “if the relationship is based on a religious teaching or belief or otherwise constitutes a part of the exercise of religion” or “where the application of the affiliation rules would substantially burden those organizations’ religious exercise.” For more information about this exception, check out the SBA’s Faith-Based Organizations FAQs here.
In the end, affiliation concerns in any form can get very, VERY complicated! If you need specific legal guidance related to your business and any potential affiliates, reach out to us.
Questions about this post? Email us or give us a call at 785-200-8919.
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