[Federal Register Volume 59, Number 35 (Tuesday, February 22, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-3670]


[[Page Unknown]]

[Federal Register: February 22, 1994]


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SMALL BUSINESS ADMINISTRATION

13 CFR Parts 108 and 120

 

Development Companies and Business Loans; Passive Business

AGENCY: Small Business Administration (SBA).

ACTION: Notice of proposed rulemaking.

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SUMMARY: This proposed rule would allow certain passive businesses to 
be eligible for SBA financial assistance under both the SBA's 
development company and 7(a) business loan programs if the real estate 
(or personal property) it holds would be used by an eligible small 
business concern in which any owner of at least 20 percent of the 
passive business owns at least 20 percent of the small business 
concern. The proposed rule would eliminate many requirements and 
restrictions which presently limit the use of real estate holding 
entities in SBA's business loan and development company programs.

DATES: Comments must be submitted on or before April 25, 1994.

ADDRESSES: Comments may be mailed to John R. Cox, Acting Assistant 
Administrator for Financial Assistance, Small Business Administration, 
409 3rd Street SW., Washington, DC 20416.

FOR FURTHER INFORMATION CONTACT:
John R. Cox, 202/205-6490.

SUPPLEMENTARY INFORMATION: Section 120.101-2(e) of SBA's regulations 
(13 CFR 120.101-2(e) (1993)) provides that a real estate holding entity 
(known as an alter ego) may be eligible as an applicant for financial 
assistance under the SBA business loan program if it is organized and 
operated for profit as a corporation, partnership or individual 
proprietorship. It must be in the business of owning and leasing 
property to an operating small business concern for the latter's 
exclusive use. There must be an identity of ownership in the borrower 
and the small business concern. The regulation also contains a 
complicated description of certain familial relationships which qualify 
as identical for purposes of ownership interest. The regulation also 
requires as collateral for the assistance that: (1) The applicant 
pledge the lease between it and the operating concern, (2) the 
operating concern must be a guarantor or coborrower on the loan, and 
(3) the owners of the operating concern must guarantee the loan.
    Section 108.8(d) of the regulations governing SBA's development 
company program (13 CFR 108.8(d) (1993)) allows a real estate holding 
entity (known as an alter ego) to be eligible for a loan made pursuant 
to that program if, among other requirements, it is a business 
organized for profit, the ownership interests in the holding entity and 
the small business concern to which it leases the property are 
identical except for the complicated exceptions with respect to 
selected family owners, the collateral for the assistance includes an 
assignment of the lease between the holding entity and the small 
business, and the small business guarantees the loan or is a co-
borrower. In addition, there is a provision which covers the 
possibility that the operating concern could sublease part of the 
property to a third party.
    These detailed requirements and restrictions are confusing and 
burdensome for the public. Numerous interpretations and guidelines have 
failed to eliminate inconsistent treatment by SBA of applicant holding 
entities from program to program. The public has become frustrated by 
some of the subtle distinctions between the two programs with respect 
to these real estate holding entities, and the SBA servicing of loans 
which have been made to them has added to the general confusion.
    SBA recognizes that valid business reasons (such as estate planning 
or tax purposes) may exist for an operating small business concern to 
spin off into an affiliate the real estate on which the operating 
concern operates its business, and SBA wants to provide assistance in 
such situations where possible. The Agency, at the same time, wants to 
ensure that it will not finance purely passive investments in real or 
personal property. The holding entity regulations were initially 
promulgated fifteen years ago to accomplish this intent, but the 
changes, revisions and amendments to the regulations have caused 
confusion, inconsistency and frustration by the public and SBA 
personnel.
    Therefore, the Agency is proposing to simplify the present 
regulations by eliminating many of the above referenced limitations and 
restrictions. This proposed regulation, if enacted in final form, would 
eliminate the inconsistency which is inherent under the present rules, 
and it would greatly assist potential small business applicants which 
seek SBA financial assistance through their real estate holding 
affiliates. The Agency will no longer refer to the real estate holding 
entity as an alter ego, but will consider it to be the passive 
business.
    It must be reiterated that SBA does not intend under this proposal 
to finance a passive business or investment property which requires no 
active involvement by the business owners. A passive business would be 
an acceptable and eligible applicant under these proposed regulations 
because it is a holding entity affiliated with an otherwise eligible 
small business concern.
    Under this proposal, a passive business applicant would be eligible 
if the real estate (or personal property) it holds would be used by an 
eligible small business concern and at least one 20 percent owner of 
the passive business also owns at least 20 percent of the small 
business concern. Under this proposal, a trust could qualify as an 
eligible passive business if the grantor or trustee of the trust owns 
at least 20 percent of the small business concern, or if a beneficiary 
of at least 20 percent of the trust assets has at least a 20 percent 
ownership in the small business concern. This ownership requirement 
would identify the passive business with the operating business for SBA 
regulatory purposes. The proposed regulation does not require that 
there be more than one 20 percent owner of both entities or that the 
principals control either entity. As long as one person is a 20 percent 
owner in both entities that would be sufficient to make an entity the 
eligibility passive business affiliate of the small business concern 
since that person would be considered to be a principal in both 
entities. Alternatively, if members of the same family (father, mother, 
son, daughter, wife, husband, brother or sister) meet the 20 percent 
ownership requirement in both the passive business and the small 
business concern they would be considered to be the same principal for 
SBA purposes.
    Both the passive business and the small business concern would be 
required to be obligated on the vote evidencing the assistance, and any 
person who has a 20 percent ownership interest in both entities would 
provide a personal guarantee to support the SBA financial assistance. 
Proprietors, partners, officers, directors and owners of 20 percent or 
more in either entity would also be subject to the collateral 
provisions set forth in Sec. 120.103-2(c) of the SBA regulations.
    Under this proposed rule, SBA would eliminate the present 
requirement in the business loan program that the passive business must 
only be a proprietorship, partnership or corporation in order to 
accommodate SBA's policy that a trust can be an eligible passive 
business if it otherwise comports with the requirements of this 
regulation. It would eliminate the present convoluted and complicated 
provisions which detail the listed family members who can hold 
ownership interests in the passive business and small business concern 
in varying percentages of ownership. It would also eliminate the 
present requirement which mandates that non-family owners have complete 
identity of interests. The purpose of these proposed changes is to 
simplify the rules and to ensure that SBA financial assistance remains 
available for a legitimate passive business affiliate of an eligible 
small business concern when the affiliate holds real estate or personal 
property leased to the small business concern and utilized for business 
purposes. SBA has proceeded in its business assistance programs on the 
assumption that a principal owns at least 20 percent of a business and, 
under Sec. 120.103-2(c) of its regulations, SBA generally requires a 
proprietor, partner, officer, director, or 20 percent owner to execute 
a personal guarantee as collateral for the assistance. This requirement 
would apply to such enumerated persons in either entity. Prudent 
standards of banking practice will continue to dictate the rules in 
providing SBA financial assistance to eligible passive businesses. In 
addition, SBA would evaluate on a case by case basis whether the small 
business concern must make use of all the real property subject to the 
lease immediately after execution or whether it could sublease part of 
the property for an interim period of time. SBA does not want to 
interpose itself into the details of the arrangements, so long as the 
Agency is assured, pursuant to the statutory provisions, that the 
financial assistance will be repaid.

Compliance With Executive Orders 12612, 12778 and 12866, the Regulatory 
Flexibility Act, 5 U.S.C. 601 et seq., and the Paperwork Reduction Act, 
44 U.S.C. ch. 35

    For purposes of the Regulatory Flexibility Act, 5 U.S.C. 601 et 
seq., SBA certifies that this proposed rule, if promulgated in final 
form, will not have a significant impact on a substantial number of 
small entities.
    SBA certifies that this proposed rule, if promulgated in final 
form, will not constitute a significant regulatory action for the 
purposes of Executive Order 12866, since the proposed change is not 
likely to result in an annual effect on the economy of $100 million or 
more.
    SBA certifies that the proposed rule, if promulgated in final form, 
would not impose additional reporting or recordkeeping requirements 
which would be subject to the Paperwork Reduction Act, 44 U.S.C. 
Chapter 35.
    SBA certifies that this proposed rule would not have federalism 
implications warranting the preparation of a Federalism Assessment in 
accordance with Executive Order 12612.
    Further, for purposes of Executive Order 12778, SBA certifies that 
this proposed rule, if promulgated in final form, is drafted, to the 
extent practicable, in accordance with the standards set forth in 
section 2 of that order.

(Catalog of Federal Domestic Assistance Programs, No. 59.012, Small 
Business Loans and No. 59.013, State and Local Development Loans)

List of Subjects

13 CFR Part 108

    Loan programs--business, Small businesses.

13 CFR Part 120

    Loan programs--business, Small businesses.

    Accordingly, pursuant to the authority contained in section 5(b)(6) 
of the Small Business Act (15 U.S.C. 634(b)(6)), SBA hereby proposes to 
amend parts 108 and 120, chapter I, title 13, Code of Federal 
Regulations, as follows:

PART 108--LOANS TO STATE AND LOCAL DEVELOPMENT COMPANIES

    1. The authority citation for part 108 would continue to read as 
follows:

    Authority: 15 U.S.C. 687(c), 695, 696, 697a, 697b, 697c.

    2. Section 108.8 would be amended by revising paragraph (d) to read 
as follows:


Sec. 108.8  Borrower requirements and prohibitions.

* * * * *
    (d) Eligibility of passive business. A concern is ineligible if it 
is a passive business primarily engaged in investing in property, 
Provided, however, That a passive business is eligible if it owns and 
leases or it proposes to own and lease real or personal property to an 
otherwise eligible small business concern so long as:
    (1) The passive business and the small business concern share a 
common principal, as defined in this paragraph (d);
    (2) The passive business engages in no activity other than 
acquiring or owning property which it leases to the small business 
concern for its exclusive use within a reasonable period of time, and 
the proceeds of any section 502 or 503 assistance are used only for 
this purpose;
    (3) The passive business and the small business concern are both 
obligated on the note evidencing the SBA assistance;
    (4) The collateral for the financial assistance includes a lien on 
the property and an assignment of the lease (including options 
exercisable by the small business concern) between the passive business 
and the small business concern, and such lease has a remaining term at 
least equal to the term of the section 502 or 503 loan;
    (5) Each person who is a principal as defined in this paragraph (d) 
must provide a personal guarantee, and Sec. 120.103-2(c) of this title 
(relating to collateral) is applicable to all persons enumerated 
therein who are associated with either entity; and
    (6) For purposes of this paragraph (d), a person is a ``principal'' 
if he or she is the legal or beneficial owner of at least 20 percent of 
both the passive business and the small business concern to which the 
passive business intends to lease real or personal property. If the 
passive business exists in the form of a trust, the trust's grantor or 
trustee would be a ``principal'' if he or she owns at least 20 percent 
of the small business concern, and a beneficiary of at least 20 percent 
of the trust's assets would be a ``principal'' if he or she owns at 
least 20 percent of the small business concern. If members of the same 
family (father, mother, son, daughter, wife, husband, brother or 
sister) meet the 20 percent ownership requirement in both the passive 
business and the small business concern they would be considered to be 
the same ``principal'' for SBA purposes.
* * * * *

PART 120--BUSINESS LOAN POLICY

    1. The authority citation for part 120 would continue to read as 
follows:

    Authority: 15 U.S.C. 634(b)(6) and 636(a) and (h).

    2. Section 120.101-2 would be amended by revising the introductory 
text and paragraph (e) to read as follows:


Sec. 120.101-2  Type of business.

    Most small concerns are eligible for Financial Assistance. The 
following types of businesses, however, are not eligible for SBA 
assistance except where otherwise stated in this section.
* * * * *
    (e) Lending or investment; eligibility of passive business. 
Concerns which are primarily engaged in the business of lending or 
investing. However, an applicant business passively engaged in 
investing in property is eligible for SBA financing or refinancing if 
it owns and leases or it proposes to own and lease real or personal 
property to an otherwise eligible small business concern, so long as:
    (1) The passive business and the small business concern share a 
common principal, as defined in this paragraph (e);
    (2) The passive business engages in no activity other than 
acquiring or owning property which it leases to the small business 
concern for its exclusive use within a reasonable period of time, and 
the proceeds of any SBA guaranteed loan shall be used only for this 
purpose or for working capital by the small business concern;
    (3) The passive business and the small business concern are both 
obligated on the note evidencing the SBA guaranteed loan;
    (4) The collateral for the financial assistance includes a lien on 
the property and an assignment of the lease (including options 
exercisable by the small business concern) between the passive business 
and the small business concern, and such lease has a remaining term at 
least equal to the term of the SBA guaranteed loan;
    (5) Each person who is a principal as defined in this paragraph (e) 
must provide a personal guarantee, and Sec. 120.103-2(c) (relating to 
collateral) is applicable to all persons enumerated therein who are 
associated with either entity; and
    (6) For purposes of this paragraph (e), a person is a ``principal'' 
if he or she is the legal or beneficial owner of at least 20 percent of 
both the passive business and the small business concern to which the 
passive business intends to lease real or personal property. If the 
passive business exists in the form of a trust, the trust's grantor or 
trustee would be a ``principal'' if he or she owns at least 20 percent 
of the small business concern, and a beneficiary of at least 20 percent 
of the trust's assets would be a ``principal'' if he or she also owns 
at least 20 percent of the small business concern. If members of the 
same family (father, mother, son, daughter, wife, husband, brother or 
sister) meet the 20 percent ownership requirement in both the passive 
business and the small business concern they would be considered to be 
the same ``principal'' for SBA purposes.
* * * * *
    Dated: November 16, 1993.
Erskine B. Bowles,
Administrator.
[FR Doc. 94-3670 Filed 2-18-94; 8:45 am]
BILLING CODE 8025-01-M