Locke Lord QuickStudy: SPECIAL ALERT: Affiliate Rule Guidance Issued for the Paycheck Protection Program

Locke Lord LLP
April 4, 2020
The SBA has issued a long-awaited guidance on the affiliation rules applicable to the Paycheck Protection Program. This guidance acts to summarize, clarify, and in some cases, modify, the rules in effect for the SBA’s 7a loan program. Four tests for affiliation based on control apply: (1) affiliation based on ownership, (2) affiliation arising under stock options, convertible securities, and agreements to merge, (3) affiliation based on management, and (4) affiliation based on identity of interest.

1. Affiliation Based on Ownership
  • The guidance confirms there is no affiliation exception for PE or VC funds who own controlling interests in portfolio companies. Therefore, if a PE or VC fund owns or has the power to control more than 50% of the applicant’s voting equity, the employees (and if applicable, revenues) of that fund and its other controlled portfolio companies are aggregated with those of the applicant in determining eligibility for the program. 

  • The guidance also retains the concept that a minority equityholder will be deemed to be in control if that equityholder has the ability, under the applicant’s organizational documents or equityholder’s agreement, to block action by the board or equityholders.
2. Affiliation Arising under Stock Options, Convertible Securities

  • The SBA treats stock options, convertible securities, and agreements to merge (including agreements in principle) as though such rights have been exercised, such that they are deemed to have a present effect on the power to control an applicant. 

  • This does not include “agreements to agree”—to negotiate or that are subject to conditions precedent incapable of fulfillment, speculative, or unenforceable or where the probability of the transaction or exercise is shown to be extremely remote.
3. Affiliation Based on Management

  • Affiliation arises where an officer or director of the applicant also controls the management of one or more other businesses. Affiliation also arises where a single individual or entity controls the management of the applicant through a management agreement.
4. Affiliation Based on Identity of Interest

  • A rebuttable presumption of affiliation arises when there is an identity of interest between close relatives with identical or substantially identical business or economic interests.

  • Unlike existing 7a loan rules, affiliation based on “identity of interest” is not triggered where firms have common investments in the same or related industries, or by virtue of economic dependence through contractual relationships.

Waiver of Affiliation Rules. The guidance did not make any changes to the waiver of affiliation rules set forth in the CARES Act and related SBA Rules. Notably, the guidance did not place any limitations on the affiliation waiver for applicants that receive financial assistance from an SBIC, such as minimum dollar thresholds or when the investment is made (but the SBIC investment must be made before the application is submitted).