COVID-19 Relief: Understanding Affiliation Rules Regarding Paycheck Protection Loans

The CARES Act states that the SBA’s affiliation rules apply regarding eligibility determinations for Paycheck Protection Loans.¹ Therefore, to properly analyze whether a company is a qualifying “small business,” one must understand the SBA’s complex affiliation rules. After using these rules to properly identify affiliated companies, potential borrowers must aggregate the respective employee tallies of each affiliated company to determine whether they are within the size limitation.

With that said, the Act also expressly waives the SBA’s affiliation rules for three types of businesses: (1) industry “Sector 72,” which applies to Accommodation and Food Services, such that businesses within this sector qualify for new loans as long as they do not have more than 500 employees at any given location; (2) franchises that are approved on the SBA’s Franchise Directory; and (3) small businesses that receive financing through the Small Business Investment Company program.

Affiliation Under SBA Regulations

The specific SBA regulation regarding affiliation principles applicable to financial assistance programs is 13 C.F.R. § 121.301. It states that for both Business Loans (like the Paycheck Protection Loans) and Disaster Loans, an applicant business concern must satisfy two criteria:

(1) The size of the applicant alone (without affiliates) must not exceed the applicable size standard; and

(2) The size of the applicant combined with its affiliates must not exceed the size standard designated for either the primary industry of the applicant alone or the primary industry of the applicant and its affiliates, whichever is higher.

It further states that:

Concerns and entities are affiliates of each other when one controls or has the power to control the other, or a third party or parties control or has the power to control both. It does not matter whether control is exercised, so long as the power to control exists. Affiliation under any of the circumstances described below is sufficient to establish affiliation for applicants for SBA’s Business Loan [and] Disaster Loan […] Programs.

The SBA recognizes numerous ways in which an individual or company may be deemed to control—and, thus, be affiliated with—another company. We summarize these considerations briefly below while noting that the law of affiliation is complex and that its nuances are found within the SBA’s interpretations of its regulations, as articulated through years of case decisions in small business size protests.

1. Ownership. A clear-cut case of affiliation exists where an individual or company owns, or has the power to control, 50 percent or more of another company’s voting stock. If no individual or company is found to control, SBA will deem the board of directors or president or CEO (or other officers, managing members, or partners who control the management of the concern) to be in control of the concern. SBA will also deem a minority shareholder to be in control, if that individual or entity has the ability, under the concern’s charter, by-laws, or shareholder’s agreement, to prevent a quorum or otherwise block action by the board of directors or shareholders.
2. Stock Options, Convertible Securities, Agreements to Merge. SBA considers stock options, convertible securities, and agreements to merge (including agreements in principle) to have present effect on the power to control a company. SBA treats such options, convertible securities, and agreements as though the rights granted have been exercised.
3. Common Management. Affiliation may arise where the CEO or president of the applicant company (or other officers, managing members, or partners who controls the management or board of the company) also controls the management or board of one or more other companies.
4. Identity of Interest. Affiliation may arise where companies share identical or substantially identical business or economic interests, such where the businesses are controlled by nuclear family members.

To ensure compliance with these rules, all applicants for a Paycheck Protection Loan should first give careful consideration to the question of affiliation. Applicants should also understand that if their application is not approved based on an adverse size determination (e.g., too many employees based on affiliation), they can appeal the decision to the SBA’s Office of Hearings and Appeals (OHA).

Additional Resources

Pillsbury attorneys can help clients interpret the foregoing requirements and determine whether to apply for an SBA loan. Section 1114 of the Act directs the SBA to pass regulations to implement the Act by April 11, 2020. We will continue to monitor the forthcoming regulations. In the meantime, please refer to our client alerts COVID-19 Relief: Understanding SBA Loan Opportunities Under the CARES Act and COVID-19 Relief: Small Business Loan Forgiveness under the CARES Act for additional information.

1.  The SBA’s affiliation rules for financial assistance programs are found in 13 C.F.R. § 121.301, promulgated in 2016. The CARES Act refers to the affiliation rules of 13 C.F.R. § 121.103, which are similar. We believe that reference to be in error as SBA regulations state that affiliation rules found in 13 C.F.R. § 121.301 apply to financial assistance programs of the type contained in the CARES Act.

Pillsbury’s experienced crisis management professionals are closely monitoring the global threat of COVID-19, drawing on the firm’s capabilities in supply chain management, insurance law, cybersecurity, employment law, corporate law and other areas to provide critical guidance to clients in an urgent and quickly evolving situation. For more thought leadership on this rapidly developing topic, please visit our COVID-19 (Coronavirus) Resource Center.