Ethan W. Smith, Esquire

On February 25, 2013, a notice of proposed rulemaking for the SBA was published in the Federal Register. One of the key changes being proposed by the Agency is the elimination of the personal resources test, which limits the amount of liquid assets a 20% or more owner of a loan applicant may retain and still get an SBA loan.

While opinions may differ regarding the impact that the elimination of the personal resources test will have, Lenders should consider the impact that the elimination of the personal resources test will have on SBA's credit elsewhere test. 13 CFR § 120.101 provides:

"SBA provides business loan assistance only to applicants for whom the desired credit is not otherwise available on reasonable terms from non-Federal sources. SBA requires the Lender or CDC to certify or otherwise show that the desired credit is unavailable to the applicant on reasonable terms and conditions from non-Federal sources without SBA assistance, taking into consideration the prevailing rates and terms in the community in or near where the applicant conducts business, for similar purposes and periods of time. Submission of an application to SBA by a Lender or CDC constitutes certification by the Lender or CDC that it has examined the availability of credit to the applicant, has based its certification upon that examination, and has substantiation in its file to support  certification." (emphasis added)

Historically, the personal resources test attempted to define when the personal resources of the principals of the small business applicant would be considered to be available as a source of "credit elsewhere". However, it is unclear from the proposal to eliminate the personal resources test, whether or not the personal resources of the principals of the applicant will be considered a "non-Federal" source of alternative financing by the agency. The agency should amend the credit elsewhere test to expressly state that the personal resources of the principals of the applicant will not be considered as an alternate non-Federal source of financing. Such a clarification is critical to provide lenders with the level of certainty necessary to provide the certification required as part of the credit elsewhere test. Absent such a clarification, the elimination of the personal resources test injects a level of uncertainty into the program regulations that will likely be a disincentive to lenders extending financing to individuals that might otherwise qualify for SBA financing after the rule change.

An additional point for consideration by lenders is the language in the proposed rulemaking towards the end of the section on the repeal of the personal resources test. The SBA states:

"The agency continues to believe, however, that the personal resources of the applicant should be taken into consideration in determining what equity injection, if any, should be required of the applicant's principals and owners. Prudent lending includes a determination that the business is adequately capitalized and, if not, that available personal resources be injected into the business." (emphasis added)

Although this language may be read as merely commentary to the proposed rule change, it appears to informally reaffirm the objectives of the personal resources test; namely to require a principal with significant liquid assets to use a portion of those assets to support the small business concern. Correct or not, the personal resources test provides lenders with a bright line rule to determine what level of capitalization is "adequate". This commentary leaves it to lenders to determine what an "adequate" level of capitalization is, and reasonable minds could disagree on this point. Such disagreement may jeopardize the loan guaranty because lenders will have to overcome potential arguments put forth by the agency (with the benefit of hindsight) that the capitalization of the failed business was inadequate. In the context of a loan default and a loss to the government, that may be a difficult argument for lenders to win. In the absence of the personal resources test, SBA should provide guidance to lenders as to the level of capitalization that it deems to be "adequate."

The goals of the agency to lessen the burden of its regulations with the aim of increasing access to its programs are admirable and should be applauded by the SBA lending community. However, additional clarifications are necessary to produce the level of certainty that lenders need to give full effect to the proposed changes. For more information on the current proposed changes to the SBA regulations, contact Ethan at 215-542-7070, or ESmith@StarfieldSmith.com.

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