[Federal Register Volume 63, Number 86 (Tuesday, May 5, 1998)]
[Proposed Rules]
[Pages 24753-24756]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-11910]


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 Proposed Rules
                                                 Federal Register
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 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
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  Federal Register / Vol. 63, No. 86 / Tuesday, May 5, 1998 / Proposed 
Rules  

[[Page 24753]]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 120


Business Loan Program

AGENCY: Small Business Administration (SBA).

ACTION: Proposed rule.

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SUMMARY: This proposed rule would implement Pub. L. 104-208, enacted on 
September 30, 1996, and Pub. L. 105-135, enacted on December 2, 1997, 
with respect to SBA financing in the 504 Program, and would clarify 
existing regulations. In the 504 program, the proposed regulations 
would authorize multiple businesses to obtain SBA financing for a 
specific 504 Project, allow a 504 Borrower to lease long term no more 
than 20 percent of the 504 Project, describe how much a Borrower must 
contribute to a 504 Project, and modify allowable fees paid by a 
Borrower, Third Party Lender, and CDC. In addition, the proposed rule 
would allow certain fees incurred by a CDC in the closing of a 504 
loan, up to $2,500 per closing, to be eligible administrative costs.

DATE: Comments must be submitted on or before July 6, 1998.

ADDRESS: Comments should be mailed to Jane Palsgrove Butler, Acting 
Associate Administrator for Financial Assistance, Small Business 
Administration, 409 Third Street, S.W., Washington, D.C. 20416.

FOR FURTHER INFORMATION CONTACT: Michael J. Dowd, 202-205-6660.

SUPPLEMENTARY INFORMATION: Public Law 105-135, the ``Small Business 
Reauthorization Act of 1997'' (1997 legislation), enacted on December 
2, 1997, and Public Law 104-208 (1996 legislation), enacted on 
September 30, 1996, amended the Small Business Investment Act of 1958 
(15 U.S.C. 601 et seq.). These proposed regulations would implement the 
amendments required by the 1996 legislation and some of the amendments 
required under the 1997 legislation, and make other changes.

Changes to the 504 Program

    The 1997 legislation and the 1996 legislation require SBA to amend 
its regulations to implement the statutes. SBA is also proposing some 
other program changes.
     Section 502 of the Act authorizes SBA to provide financial 
assistance through a CDC to assist a small business concern to acquire, 
construct, convert, or expand its plant facility as a 504 Project 
pursuant to section 504 of the Act. SBA interpreted the statute to 
permit the Agency to assist only one identifiable business for any 
particular project. The 1997 legislation authorizes SBA to provide such 
financial assistance to more than one identifiable small business. SBA 
proposes to amend Section 120.801 of its regulations to allow SBA to 
work with a CDC to assist multiple small businesses for any specific 
504 Project, allowing two or more unrelated small businesses to seek 
SBA financial assistance for a qualified 504 Project.
     SBA is also proposing to amend its regulations with 
respect to Eligible Passive Companies in order to make that rule 
consistent with the 1997 legislation. Current 13 CFR 120.111 allows SBA 
to assist an Eligible Passive Company to use loan proceeds to acquire 
property to lease to an Operating Company. SBA is proposing to amend 13 
CFR 120.111 to authorize SBA to provide financing to an Eligible 
Passive Company which could use the proceeds to lease property to 
multiple unrelated Operating Companies. This proposed change would make 
the Eligible Passive Company provision consistent with the proposed 
change to 13 CFR 120.801.
     The 1996 legislation amended the Act with respect to the 
amount of a Borrower's contribution to the financing of a 504 Project. 
SBA is proposing to amend 13 CFR 120.910 of its regulations to require 
the Borrower to contribute at least 15 percent of the total cost of the 
504 Project if the Borrower (or Operating Company if the Borrower is an 
Eligible Passive Company) has been in business for 2 years or less, or 
if the Project is the acquisition, construction, conversion, or 
expansion of a limited or single purpose building. The Borrower must 
contribute at least 20 percent of the total cost of the Project if both 
these conditions exist.
     The 1996 legislation requires that not less than 50 
percent of a Project's cost must be financed by a Third Party Lender if 
the Borrower's contribution is made under the conditions described 
above for proposed 13 CFR 120.910. This proposed revision of 13 CFR 
120.920 implements that change.
     The 1997 legislation amended the Act to permit a 504 
Borrower to lease long term no more than 20 percent of a new 504 
Project if the Borrower would immediately occupy no less than 60 
percent of the property. To comply with the 1997 legislation, SBA is 
proposing to amend 13 CFR parts 120.131 and 120.870 to authorize a 
Borrower to lease long term up to 20 percent of the rentable space in a 
504 Project to third parties when the Borrower will occupy at least 60 
percent of the rentable space with plans to occupy another 20 percent 
of the rentable space within 3 years. The present law allows a Borrower 
in a 504 Project to lease up to 33 percent of a new facility if the 
Borrower can show that it will need additional space within 3 years and 
that it will fully use the facility within 10 years. Under the proposed 
rule, the Borrower will have the option of showing that it will 
ultimately use 80 percent of the rentable space within 3 years, and 
that it plans to lease long term 20 percent of the space to others. The 
effect of this change will be to allow a business to construct a 
building in a good location without being compelled to show that it 
will use all of the space. Thus, the proposed rule will alleviate the 
present strict restrictions on the use of property.
     13 CFR 120.862(b) sets forth specific public policy goals 
a CDC may use to qualify a 504 Project or support an increased amount 
of 504 financing. 13 CFR 120.862(b)(3) lists expanding Minority 
Enterprise Development as one of the public policy goals. SBA is 
proposing to amend 13 CFR 120.862(b)(3) to direct the reader to the 
correct section in SBA's regulation designating the specific minority 
groups to which the subsection applies. 13 CFR 120.862 (b)(7) lists as 
one of the public policy goals the assistance of businesses affected by 
Federal budget reductions. SBA is proposing to amend 13 CFR 
120.862(b)(7) by clarifying that the public policy goal is to assist 
any eligible small business in an area

[[Page 24754]]

affected by such reductions, not only those businesses which can show 
that they were affected adversely by the budget reduction. Therefore, 
if a geographic area has been adversely affected by Federal budget 
reductions, SBA can assist a business located in that area or moving to 
that area without showing that the particular business was affected.
     The 1996 legislation requires SBA to charge the Borrower a 
fee of not more than 0.9375 percent on the unpaid principal balance of 
the loan as determined at 5-year anniversary intervals. SBA is amending 
13 CFR 120.971 of its regulations to implement this change. In 
addition, 13 CFR 120.971(a)(3) raises the minimum servicing fee from .5 
percent to .625 percent.
     SBA is proposing to insert a new Section 120.972 in 13 CFR 
to implement the 1996 legislation which requires SBA to collect a one-
time fee equal to 50 basis points on the total participation in a 
Project by a Third Party Lender when that Third Party Lender occupies a 
senior credit position to that of SBA. In addition, under the proposed 
regulation, SBA will collect an annual fee from each CDC equal to 0.125 
percent of the outstanding principal balance of any Debenture 
guaranteed by SBA after September 30, 1996. The CDC must pay the fee 
from the servicing fees collected by the CDC and not from additional 
fees imposed on the Borrower.
     Currently, under 13 CFR 120.921(d), any future advance by 
a Third Party Lender in excess of the outstanding balance and accrued 
interest must be subordinated to the CDC/SBA lien unless the future 
advance is to collect payments, maintain collateral, or protect the 
Third Party Lender's lien position on the Third Party Loan. SBA has 
been unable at times to realize the full benefit of its lien position, 
despite its regulations requiring future advances to be subordinate to 
the CDC/SBA lien.
    Moreover, if a Third Party Lender wants to make additional capital 
available to a 504 Borrower, it easily can do so through another loan. 
SBA is proposing to revise 13 CFR 120.921(d) to state that the Third 
Party Loan cannot be open-ended as to amount, and after completion of 
the 504 Project, a Third Party Lender may only make a future advance 
under the Third Party Loan to collect amounts due on the Third Party 
Loan note, maintain collateral or protect its lien.
     SBA also has been unable to realize the full benefit of 
its lien position because of prepayment penalties, late fees, and 
escalated interest after default due under the Third Party Loan. 
Accordingly, SBA also proposes to add a new paragraph (e) to 13 CFR 
120.921 that would state that the Third Party Lender's lien is 
subordinate to the CDC/SBA lien with respect to prepayment penalties, 
late fees, and escalated interest after default due under the Third 
Party lien.
     When a small business defaults on a Third Party Loan, SBA 
may choose to assume the obligations of the Borrower. The 1996 
legislation amended the Act to ensure that when SBA assumes such 
obligation for Projects approved after September 30, 1996, it only will 
pay the interest rate on the note in effect immediately prior to the 
date of the Borrower's default. SBA is proposing to redesignate and 
revise present paragraph (e) of Section 120.921 of 13 CFR to become new 
paragraph (f) stating that SBA only will pay the interest rate in 
effect immediately prior to the date of the Borrower's default with 
respect to a Project approved after September 30, 1996.
     SBA is proposing to amend 13 CFR 120.802 to clarify the 
definition for Third Party Loan and 13 CFR 120.801(c)(3) to reflect 
that definition.
     Currently, Section 120.870(c)(1) of 13 CFR requires the 
term of a lease of the Project premises to be at least equal to the 
terms of the Debenture. However, this may not be necessary if the 
Project is only machinery and equipment. Therefore, SBA proposes to 
delete machinery and equipment from the definition to clarify that the 
length of a lease for machinery and equipment is a credit issue.

Changes to CDC Closing Fees

    Section 120.883 of 13 CFR sets forth administrative costs which may 
be paid with the proceeds of a loan funded by a 504 Debenture rather 
than out of the Borrower's own resources. Section 120.971 of 13 CFR 
sets forth the fees that a CDC may charge a Borrower.
    Throughout the history of the 504 Program, most of the services 
required to prepare 504 loan documents and close a 504 loan have been 
performed for CDCs, at CDC cost, by legal counsel, paralegals, and CDC 
staff. The CDC has then charged its Borrower a fee at closing to 
reimburse the CDC for these expenses (``CDC Closing Fee''). Although 
this CDC Closing Fee reimburses the CDC for expenses the CDC pays to 
its own lawyers, the Borrower is not considered to be paying a legal 
fee, since the Borrower is not represented by CDC counsel. The Borrower 
pays separately the legal fees of its legal counsel.
    Under the 504 Program, loan proceeds may be used to pay eligible 
Project costs and eligible administrative costs. Eligible Project costs 
are costs directly attributable to the Project including professional 
fees essential to the Project for services such as architecture, 
engineering, and environmental studies. The Borrower's legal fees for 
Project-related matters such as zoning, title searches, and recording 
fees, as well as interest and points on the interim construction loan, 
are eligible Project costs. The Borrower's legal fees associated with 
the closing are not eligible Project costs.
    Eligible administrative costs are amounts the Borrower pays for 
services connected with closing, but not directly attributable to the 
Project itself. These include SBA's guarantee fee, the CDC's processing 
fee, and 504 closing agent fees. The Borrower's legal fees associated 
with the closing are not eligible administrative costs. Until March 1, 
1996, the CDC Closing Fee was an eligible administrative cost. By 
regulation, the Borrower could pay the CDC Closing Fee out of the 
proceeds of a 504 loan up to a maximum of $2,500. Since then, SBA has 
not recognized the CDC Closing Fee as an eligible administrative cost, 
and Borrowers must reimburse the CDC out of their own resources.
    CDCs, Borrowers, and SBA share a common interest in minimizing 
legal fees to reduce costs to the Borrower. During the period before 
March 1, 1996, some in the 504 industry felt that SBA's regulation 
influenced the market rate for legal fees and other miscellaneous 
expenses associated with 504 Closings. They argued that attorney fees 
charged CDCs by CDC counsel were maintained at an artificially high 
level because the CDC Closing Fee was an eligible administrative cost 
financed out of the loan proceeds. They further argued that the 
reference in the regulation to a $2,500 limitation established a 
minimum base for the attorney fees.
    SBA received 15 comments concerning these issues during the comment 
period following publication of its proposed rule changes in 60 FR 
64356 on December 15, 1995. Most of them supported retaining the CDC 
Closing Fee as an eligible administrative cost. SBA believed, however, 
that legal expenses associated with the 504 Closing should be 
determined by the competitive marketplace and that there was some merit 
in the contention that the eligibility of the CDC Closing Fee as an 
administrative cost resulted in higher attorney fees. Despite the 
opposition expressed in most of the comments received, SBA decided to 
exclude the

[[Page 24755]]

CDC Closing Fee from eligible administrative costs and eliminated the 
$2,500 reference in its final rule published in 61 FR 3226, dated 
January 31, 1996.
    SBA expected that these regulatory changes would reduce attorney 
fees. It also anticipated downward competitive pressure on such fees as 
more attorneys became designated to perform expedited 504 loan 
closings.
    CDCs have been closing loans under the new rules for nearly 2 
years. Approximately 140 attorneys are now enrolled as designated 
closing attorneys, and more than 50 percent of all 504 loans close 
under the expedited process. Yet fees associated with 504 closings 
charged CDCs by CDC counsel do not appear to have decreased.
    Legislation enacted since the rule became effective has imposed 
additional fees upon Borrowers. Industry representatives indicate that 
the combination of increased fees and the inability to pay the CDC 
Closing Fee out of the Debenture proceeds has reduced access by small 
businesses to the 504 Program. Because the fees now are not eligible 
administrative costs, they must be paid by the Borrowers from other 
resources. Not all Borrowers can afford to pay these costs without use 
of the Debenture proceeds.
    In an effort to assist its small business customers, SBA is 
proposing to make CDC Closing Fees eligible administrative costs up to 
a maximum of $2,500 per Closing.

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)

    SBA certifies that this proposed rule does not constitute a 
significant rule within the meaning of Executive Order 12866, since it 
is not likely to have an annual effect on the economy of $100 million 
or more, result in a major increase in costs or prices, or have a 
significant adverse effect on competition or the U.S. economy.
    SBA certifies that this proposed rule will not have a significant 
economic impact on a substantial number of small entities within the 
meaning of the Regulatory Flexibility Act, 5 U.S.C. 601, et seq. Last 
year, SBA made approximately four thousand 504 loans. Currently there 
are approximately 300 CDCs, less than 15 of which are Premier CDCs. 
While the 1997 legislation removes the limit on the number of CDCs that 
can become Premier CDCs, SBA anticipates that, at most, only half of 
the CDCs would be affected by this rule. Thus the changes to the 
Program in the proposed rule, including the changes to the Closing Fee 
provisions and the changes implementing P.L. 104-208 and P.L. 105-135 
will not constitute a significant impact on a substantial number of 
small businesses.
    SBA certifies that this proposed rule does not impose any 
additional reporting or recordkeeping requirements under the Paperwork 
Reduction Act, 44 U.S.C. chapter 35.
    For purposes of Executive Order 12612, SBA certifies that this 
proposed rule has no federalism implications warranting preparation of 
a Federalism Assessment.
    For purposes of Executive Order 12778, SBA certifies that this 
proposed rule is drafted, to the extent practicable, to accord with the 
standards set forth in section 2 of that Order.

List of Subjects in 13 CFR Part 120

    Loan programs--business, Small businesses.

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

PART 120--BUSINESS LOANS

    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. Amend Sec. 120.111 by revising the first sentence to read as 
follows:


Sec. 120.111  What conditions must an Eligible Passive Company satisfy?

    An Eligible Passive Company must use loan proceeds to acquire or 
lease, and/or improve or renovate real or personal property (including 
eligible refinancing) that it leases to one or more Operating Companies 
for the conduct of the Operating Company's business (references to one 
Operating Company include multiple Operating Companies, as applicable). 
* * *
* * * * *
    3. Amend Sec. 120.131(a) by adding a new sentence at the end to 
read as follows:


Sec. 120.131  Leasing part of new construction or existing building to 
another business.

    (a) * * * (See Sec. 120.870(c) for an exception with respect to 504 
Projects.)
* * * * *
    4. Amend Sec. 120.801 by revising the first sentence of paragraph 
(a) and paragraph (c)(3) to read as follows:


Sec. 120.801  How is a 504 Project financed?

    (a) One or more small businesses may apply for 504 financing 
through a CDC serving the area in which the 504 Project is located. * * 
*
* * * * *
    (c) * * *
    (3) Third Party Loan comprising the balance of the financing, 
collateralized by a first lien on the Project property (see section 
120.920).
* * * * *
    5. Amend Sec. 120.802 by revising the definition of Third Party 
Loan to read as follows:


Sec. 120.802  Definitions.

* * * * *
    Third Party Loan is a loan from a commercial or private lender, 
investor, or Federal (non-SBA), State or local government source that 
is part of the Project financing.
* * * * *
    6. Amend Sec. 120.862 by revising the parenthetical clause in 
paragraph (b)(3) and by revising paragraph (b)(7) to read as follows:


Sec. 120.862  Other economic development objectives.

* * * * *
    (b) Public Policy goals: * * *
    (3) * * * (See Sec. 124.105(b) for minority groups who qualify for 
this description.);
* * * * *
    (7) Assisting businesses in or moving to areas affected by Federal 
budget reductions, including base closings, either because of the loss 
of Federal contracts in the area or the reduction in revenues in the 
area due to a decreased Federal presence.
    7. Amend Sec. 120.870 by revising paragraph (a)(1) and adding a new 
paragraph (c) to read as follows:


Sec. 120.870  Leasing Project Property.

    (a) * * *
    (1) The remaining term of the lease, including options to renew, 
exercisable solely by the lessee, equals or exceeds the term of the 
Debenture;
* * * * *
    (c ) If the Project is for new construction, a Borrower may lease 
long term no more than 20 percent of the rentable property in the 
Project to one or more tenants if the Borrower immediately occupies not 
less than 60 percent of the rentable property with plans to occupy the 
remaining 20 percent within 3 years.
    8. Revise Sec. 120.883 to read as follows:

[[Page 24756]]

Sec. 120.883  Eligible administrative costs for 504 loans.

    The following administrative costs are not part of Project costs, 
but may be paid with the proceeds of the 504 loan and the Debenture 
(see Sec. 120.971):
    (a) SBA guarantee fee;
    (b) Funding fee (to cover the cost of a public issuance of 
securities and the Trustee);
    (c) CDC processing fee;
    (d) Borrower's out-of-pocket costs associated with the closing of 
the 504 loan (other than legal fees);
    (e) CDC Closing Fee (see Sec. 120.971(a)(2)) up to a maximum of 
$2,500; and
    (f) Underwriters' fee.
    9. Revise Sec. 120.910 to read as follows:


Sec. 120.910  How much must the Borrower contribute?

    (a) The Borrower must contribute to the Project cash (or property 
acceptable to SBA obtained with the cash) or land (that is part of the 
Project Property), in an amount equal to the following percentage of 
the Project cost, exclusive of administrative cost:
    (1) At least 15 percent, if the Borrower (or Operating Company if 
the Borrower is an Eligible Passive Company) has been in operation for 
2 years or less;
    (2) At least 15 percent, if the Project involves the acquisition, 
construction, conversion, or expansion of a limited or single purpose 
building or structure;
    (3) At least 20 percent, if the Project involves both of the 
conditions described in paragraphs (a) (1) and (2) of this section; or
    (4) At least 10 percent, in all other circumstances.
    (b) The source of the contribution may be a CDC or any other source 
except an SBA business loan program (see Sec. 120.913 for SBIC 
exception).
    10. Revise Sec. 120.920 to read as follows:


Sec. 120.920  Required participation by the Third Party Lender.

    (a) Amount of Third Party Loans. A Project financing must include 
one or more Third Party Loans totaling at least as much as the 504 
loan. However, the Third Party Loans must total at least 50 percent of 
the total cost of the Project if:
    (1) The Borrower (or Operating Company, if the Borrower is an 
Eligible Passive Company) has been in operation for 2 years or less, or
    (2) The Project is for the acquisition, construction, conversion, 
or expansion of a limited or single purpose asset.
    (b) Third Party Loan collateral. Third Party Loans usually are 
collateralized by a first lien on the Project property. They cannot be 
guaranteed by SBA.
    11. In Sec. 120.921 revise and redesignate paragraphs (d) and (e) 
as paragraphs (e) and (f) and add a new paragraph (d) to read as 
follows:


Sec. 120.921  Terms of Third Party Loans.

* * * * *
    (d) Future advances. The Third Party Loan must not be open-ended. 
After completion of the Project, the Third Party Lender may not make 
future advances under the Third Party Loan except expenditures to 
collect amounts due the Third Party Loan notes, maintain collateral, 
and protect the Third Party Lender's lien position on the Third Party 
Loan.
    (e) Subordination. The Third Party Lender's lien will be 
subordinate to the CDC/SBA lien as to any prepayment penalties, late 
fees, and increased default interest due under the Third Party Loan.
    (f) Escalation upon default. A Third-Party Lender may not escalate 
the rate of interest upon default to a rate greater than the maximum 
rate set forth in paragraph (b) of this section. With respect to any 
Project approved after September 30, 1996, SBA will only pay the 
interest rate on the note in effect prior to the date of the Borrower's 
default.
    12. Amend Sec. 120.971 by revising the first sentence of paragraph 
(a)(2) and paragraphs (a)(3), and (d)(2) to read as follows:


Sec. 120.971  Allowable fees paid by Borrower.

    (a) * * *
    (2) Closing fee. The CDC may charge a reasonable closing fee in an 
amount sufficient to reimburse it for the expenses of its in-house or 
outside legal counsel, and other miscellaneous closing costs (CDC 
Closing Fee). * * *
    (3) Servicing fee. The CDC will charge a monthly servicing fee of 
not less than 0.625 percent per annum nor more than 2 percent per annum 
on the unpaid balance of the loan as determined at 5-year anniversary 
intervals. A servicing fee in excess of 1.5 percent in a Rural Area and 
1 percent everywhere else requires SBA's prior written approval, based 
on evidence of substantial need. The servicing fee may be paid only 
from loan payments received. The fees may be accrued without interest 
and collected from the CSA when the payments are made.
* * * * *
    (d) * * *
    (2) For loans approved by SBA after September 30, 1996, SBA charges 
a fee of not more than 0.9375 percent per annum on the unpaid principal 
balance of the loan as determined at 5-year anniversary intervals.
* * * * *
    13. In part 120 redesignate Sec. 120.972 as Sec. 120.973, and add a 
new Sec. 120.972 to read as follows:


Sec. 120.972  Third Party Lender participation fee and Development 
company fee.

    (a) Participation fee. For loans approved by SBA after September 
30, 1996, SBA must collect a one-time fee from the Third Party Lender 
equal to 50 basis points on its total participation in a Project when 
the Third Party Lender occupies a senior credit position to SBA in the 
project.
    (b) Development company fee. For loans approved by SBA after 
September 30, 1996, SBA must collect an annual fee from the CDC equal 
to 0.125 percent of the outstanding principal balance of the debenture. 
The fee must be paid from the servicing fees collected by the CDC and 
cannot be paid from any additional fees imposed on the Borrowers.

    Dated: April 28, 1998.
Aida Alvarez,
Administrator.
[FR Doc. 98-11910 Filed 5-4-98; 8:45 am]
BILLING CODE 8025-01-P