On April 3, 2020, the Small Business Administration (SBA) released its second Interim Final Rule in as many days addressing the affiliation rules that apply to the Paycheck Protection Program (PPP). A copy of the second Interim Final Rule can be found here. Those in the Venture Capital and Private Equity industries are hoping that additional guidance will be issued to ease the applicability of the affiliation rules to their portfolio companies under the PPP.  That did not happen with the second Interim Final Rule and accompanying guidance issued on April 3, which accompanying guidance can be found here. No new exclusions were added and the exclusions still apply only to:

  • Any business concern with not more than 500 employees[1] that, as of the date on which the loan is disbursed, has been assigned a NAICS code beginning with 72;
  • Any business concern operating as a franchise that is assigned a franchise identifier code by the SBA; and
  • Any business concern that receives financial assistance from an SBIC.

This is an evolving area, and it is possible that additional guidance will be released in the coming week on the PPP.  As of April 4, 2020, here is what potential applicants need to know.

What Has Changed Under The Second Interim Final Rule?

There have been no significant changes to the guidance provided in our previous blog posts regarding the affiliation rules (expanded FAQs and updated guidance on PPP loans).  The second Interim Final Rule clarified that the SBA’s affiliation rule in 13 C.F.R. § 121.301 applies to PPP loans and that affiliation can be found in any of the following circumstances:

  • Affiliation based on ownership: A business concern is an affiliate of an individual, concern or entity (collectively a Person) that owns or has the power to control more than 50% of the Person’s voting equity. If no one Person has greater than 50% ownership or control, the SBA will deem the board of directors or president or CEO (or other officers, managing members or partners who control the management of the concern) to be in control of the business concern, subject to the presence of negative control by a minority shareholder or other bases of affiliation described below.
  • Affiliation based on minority shareholder control: SBA will deem a minority shareholder to be in control if that minority shareholder has the ability, under a Person’s charter, by-laws, or shareholder agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.
  • Affiliation arising under stock options, convertible securities, and agreements to merge:  In determining affiliation, the SBA considers stock options, convertible securities and agreements to merge to have a present effect on the power to control, and will assume that such options, convertible securities and agreements have been exercised unless:
    • It is an agreement to open or continue negotiations towards the possibility of a merger or sale of stock at a later date;
    • Such options, convertible securities and agreements are subject to conditions precedent that are incapable of fulfillment because they are unenforceable, speculative and the like, or where the probability of occurrence is extremely remote; and
    • The Person in control terminates its control rights; but the SBA will not recognize the relinquishment of control rights through options, convertible securities or agreements to terminate control rights unless such control has actually been relinquished.
  • Affiliation based on management: Affiliation arises where the CEO or president (or other officers, partners or members who control management of the business) also controls the management of one or more other businesses, and also in cases where management is controlled pursuant to a management agreement; and
  • Affiliation based on identity of interest:  Affiliation arises when there is an identity of interest between close relatives with identical or substantial identical businesses or economic interests. A determination by the SBA that interests must be aggregated may be rebutted with evidence showing that the interests are in fact separate.

These and other potential bases of affiliation, including common investments, economic dependence, and close family relationships, underscore the ongoing necessity for each potential applicant for a PPP loan to analyze its affiliation status on a case-by-case basis, considering its own unique circumstances.

I Have Already Started or Completed My Eligibility Analysis Under The PPP.  Do I Need to Revisit My Previous Affiliation Analysis As Part of That Process?

Applicants still need to review their capitalization tables, shareholder agreements and other governing documents to evaluate whether provisions in those documents give minority owners either affirmative or negative control.  To the extent a previous analysis is impacted by the clarifications noted above, applicants should review the prior analysis.  For example, if a Person controlling a company recently entered into an agreement to relinquish that control, that relinquishment must have actually occurred to have any bearing on PPP loan eligibility.  SBA would not deem it to have occurred based merely on the existence of the agreement. Moreover, if such an agreement provides for the relinquished control to spring back to life after the loan period or at a particular time in the future, it is likely that SBA would give present effect to the restored control and deem the relinquishment to be ineffective.

The PPP Is First Come, First Served. Can My Business Apply For a PPP Loan If It Is Not Eligible Now But May Become Eligible If Favorable Guidance On The Affiliate Rules Is Ultimately Released?

No.  An applicant must have a good-faith, reasonable belief that it is eligible at the time it submits the application for a PPP loan.  If a company certifies its eligibility without a good-faith, reasonable basis for doing so, the company, the individual certifying, and possibly other individuals may be exposed to significant civil and perhaps even criminal liability depending on the circumstances.

[1] In its discussion of how affiliation rules affect eligibility for PPP loans, the second Interim Final Rule states that “an entity generally is eligible for the PPP if it . . . has 500 or fewer employees whose principal place of residence is in the United States[.]” See page 5 (emphasis added). The emphasized language in the previous sentence does not appear in the CARES Act and it is not in existing SBA regulations that explain how to calculate a company’s number of employees.  In fact, 13 CFR § 121.106(b)(1) expressly requires companies to count all of the employees of their domestic and foreign affiliates.  Had the SBA intended to allow companies to exclude their non-U.S. employees for purposes of determining PPP loan eligibility, one might have expected a clearer statement of that intent in the second Interim Final Rule and/or an amendment of an existing regulation.  SBA provided neither, however, which leaves the issue cloudy until and unless the SBA issues further guidance.