BEST PRACTICES: THE ELIGIBLE PASSIVE COMPANY (EPC) RULE

Ethan W. Smith, Esq.

The SBA's Eligible Passive Company (EPC) rules and regulations can be both complex and confusing for lenders. SBA lenders often ask when a loan must be structured as an EPC/OC loan. Additionally, the particular facts and requirements of some transactions and certain Borrowers do not fit into the EPC requirements. Accordingly, SBA lenders must take care to ensure that they are using the EPC structure appropriately and in compliance with SBA requirements.

Generally, it is important for lenders to remember that the EPC rule is an exception to the SBA's general prohibition against making SBA loans to passive entities or to finance assets held for passive income or investment purposes. Because the EPC rule is an exception to an eligibility rule, it is interpreted strictly by the SBA, and failure to comply will result in a recommendation for a denial of the SBA guaranty.

A few guidelines to keep in mind for loans with an EPC/OC structure:

an EPC can take any legal form or ownership structure, including corporations, LLC's, partnerships, trusts or joint ownership such as a Tenancy in Common. Multiple EPCs in one transaction are not permitted (although a Tenancy in Common, while comprised of multiple individuals, is considered one legal form for this purpose);

an EPC 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 (OC) for conducting the OC's business. If the purpose of your loan is not for the listed purposes (i.e.: working capital), an EPC/OC structure is not required;

The EPC (with the exception of a trust) and the OC each must be small under the appropriate SBA size standards;

The EPC must lease the 100% of the rentable project property directly to the OC and:

(1) The lease must be in writing;

(2) The lease must be subordinated to the Lender's lien on the property;

(3) The lease must have a term, including options to renew exercisable solely by the OC, at least equal to the term of the loan;

(4) The EPC must assign all rents paid under the lease as collateral for the Loan;

(5) The rent or lease payments cannot exceed the amount necessary to make the loan payment to the lender, and an additional amount to cover the EPC's expenses of holding the property, such as maintenance, insurance and property taxes.

Again, because the EPC rule is an exception to SBA eligibility policy, it is strictly enforced. Avoid costly mistakes by ensuring that all of the requirements for the EPC rule have been satisfied. Failure to ensure that all of the conditions have been met for the EPC rule could result in a complete denial of your SBA guaranty.

For more information on the EPC rule and other SBA eligibility issues, contact Ethan Smith at: 215-542-7070 or esmith@starfieldsmith.com.

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