On April 2, 2012, the Small Business Administration published a "Direct Final Rule" in the Federal Register, (Vol. 77, No. 63, April 2, 2012) which provides much-anticipated clarification to the EPC rule set forth at 13 CFR 120.111. The Direct Final Rule is the product of, and SBA's response to, the controversy surrounding the SBA's 2011 change in its interpretation of the EPC rule as set forth in SOP 50 10 5(D), which purported to restrict SBA lenders from utilizing an EPC-OC structure for mixed-purpose loans that included use of proceeds by the OC for purposes other than working capital (such as business acquisition, purchase of intangible assets or goodwill). Since the effective date of SOP 50 10 5(D), Lenders have been struggling to comply with the EPC rule reinterpretation and have often been forced to split or restructure loans in order to comply with the rule reinterpretation set forth in the SOP, often to the detriment of both the Lenders and their borrower customers. The clarification SBA provided by the SBA makes the EPC rule consistent with industry practice as it existed prior to the issuance of SOP 50 10 5(D) in the Fall of 2011.

The Direct Final Rule clarifies the EPC rule, stating that: "The practice of structuring a loan with the real estate held by an EPC that leases the real estate to the OC for operation of its business has become increasingly common. Further, it has come to SBA's attention that many participating lenders have interpreted this rule to allow EPCs and OCs to borrow funds for the OC's purchase of other assets for its use, including the purchase of stock or intangible assets (such as trademarks, copyrights, intellectual property, or goodwill), as long as the OC was a co-borrower with the EPC. SBA recognizes the need for this type of financing." Federal Register Volume 77, Number 63 (Monday, April 2, 2012), page 19532. The Direct Final Rule allows the OC to utilize loan proceeds for "working capital and/or the purchase of other assets, including intangible assets," provided that the OC is a co-borrower with the EPC on the loan. Federal Register Volume 77, Number 63 (Monday, April 2, 2012), page 19533 (to be codified at 13 CFR §120.111). The clarification provides Lenders with the ability to structure mixed-purpose loans for their borrowers without imposing undue hardship by either requiring the loan to be split into two loans or requiring that the loan be restructured.

The Direct Final Rule will become effective on May 17, 2012, unless the SBA receives significant adverse comment in the next 30 days. Interestingly, even though the SBA states that this clarification brings the rule into conformance with long-standing industry practice, the rule states that it does not have any "retroactive effect." Id. at page 19532. The lack of retroactive effect presents Lenders with some uncertainty regarding how Lenders should structure loans during the six-week period between the issuance of the rule and its effective date, as well as how the Agency will treat EPC-OC loans that were "improperly" structured during the last 6 months. Accordingly, because this clarification is not retroactive, the best practice for Lenders is to delay approval of mixed-purpose EPC-OC loans until after the May 17, 2012 effective date. Although it is unlikely that significant adverse comment will be received by the SBA, Lenders could potentially risk their guaranty by failing to wait for the Direct Final Rule to become effective.