As many of you are aware, the Small Business Administration ("SBA) recently released a new version of the Standard Operating Procedures, SOP 50 10 5(C), which will go into effect October 1, 2010.  Because franchise eligibility issues have become an increasingly frequent reason for recommended denials of the SBA guaranty, it is important for lenders to understand and properly apply the new requirements relating to franchises.  The major changes relating to franchises are:

1. The SBA requires the franchise agreement and all amendments or addendums to be executed by all parties prior to the first loan disbursement.  While this may seem easy enough, many franchisors refuse to execute a franchise agreement until they are sure that the borrower has financing in place and the loan has disbursed.  In the past, lenders may have accepted draft franchise agreements for purposes of closing and may have made the fully executed franchise agreement a post closing item.  The SBA specifically prohibits this practice now.  One possible way to address this potential roadblock would be to ask the franchisor to add language to the agreement that acknowledges the agreement is null and void if Borrower's financing falls through. 
2. Lenders may still contact the SBA at franchise@sba.gov to request statistical information on SBA lending with respect to a specific franchise.  But the SBA now requires lenders to go to www.sba.gov/electroniclending to check the Franchise Findings List for information relating to a specific franchise agreement.  This website will be active by the time the new SOPs are in effect.  Lenders should closely review the findings and see whether or not SBA counsel has determined a franchise agreement to be ineligible or has negotiated a potential fix in the past.  If the franchise agreement has been determined ineligible on the Franchise Findings List with no fix negotiated, the franchise agreement should be determined ineligible if the problem sections remain in the agreement.
3. The requirements have not changed relating to footnotes on the Franchise Registry, but clarification has been added.  A franchise may be listed on the Registry, but in order to be eligible, additional amendments or addendums may be required per the footnotes.  The SOPs now specifically state that fitness centers that appear to cater to one gender but have a policy allowing both genders to use the facility must submit (a) an affidavit that men and women are allowed to use the facility and (b) a layout of the facility showing two separate bathrooms/changing rooms. 
4. The franchise agreement may not include a right of first refusal on a partial transfer of ownership within the franchisee entity, as this is deemed to create excessive control or affiliation.  But keep in mind, the SBA does not prohibit a right of first refusal on transfer of the entire ownership. 
5. The SBA has clarified that an oil company may install a credit card system to provide for payment of gasoline products and this arrangement, by itself, does not create excessive control or affiliation. 

It is important for lenders to be aware of these new provisions when reviewing franchise agreements for eligibility.  An incorrect decision regarding eligibility will lead to an automatic recommendation for denial of the SBA guaranty.  For more information on franchise issues, contact Katie at kobrien@starfieldsmith.com or 215.542.7070.