Business Loan Program

SMALL BUSINESS ADMINISTRATION

13 CFR Part 120

Business Loan Program

AGENCY: Small Business Administration (SBA).

ACTION: Proposed rule.

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SUMMARY: This proposed rule would implement Pub. L. 104-208, enacted on

September 30, 1996, and Pub. L. 105-135, enacted on December 2, 1997,

with respect to SBA financing in the 504 Program, and would clarify

existing regulations. In the 504 program, the proposed regulations

would authorize multiple businesses to obtain SBA financing for a

specific 504 Project, allow a 504 Borrower to lease long term no more

than 20 percent of the 504 Project, describe how much a Borrower must

contribute to a 504 Project, and modify allowable fees paid by a

Borrower, Third Party Lender, and CDC. In addition, the proposed rule

would allow certain fees incurred by a CDC in the closing of a 504

loan, up to $2,500 per closing, to be eligible administrative costs.

DATE: Comments must be submitted on or before July 6, 1998.

ADDRESS: Comments should be mailed to Jane Palsgrove Butler, Acting

Associate Administrator for Financial Assistance, Small Business

Administration, 409 Third Street, S.W., Washington, D.C. 20416.

FOR FURTHER INFORMATION CONTACT: Michael J. Dowd, 202-205-6660.

SUPPLEMENTARY INFORMATION: Public Law 105-135, the ``Small Business

Reauthorization Act of 1997'' (1997 legislation), enacted on December

2, 1997, and Public Law 104-208 (1996 legislation), enacted on

September 30, 1996, amended the Small Business Investment Act of 1958

(15 U.S.C. 601 et seq.). These proposed regulations would implement the

amendments required by the 1996 legislation and some of the amendments

required under the 1997 legislation, and make other changes.

Changes to the 504 Program

The 1997 legislation and the 1996 legislation require SBA to amend

its regulations to implement the statutes. SBA is also proposing some

other program changes.

Section 502 of the Act authorizes SBA to provide financial

assistance through a CDC to assist a small business concern to acquire,

construct, convert, or expand its plant facility as a 504 Project

pursuant to section 504 of the Act. SBA interpreted the statute to

permit the Agency to assist only one identifiable business for any

particular project. The 1997 legislation authorizes SBA to provide such

financial assistance to more than one identifiable small business. SBA

proposes to amend Section 120.801 of its regulations to allow SBA to

work with a CDC to assist multiple small businesses for any specific

504 Project, allowing two or more unrelated small businesses to seek

SBA financial assistance for a qualified 504 Project.

SBA is also proposing to amend its regulations with

respect to Eligible Passive Companies in order to make that rule

consistent with the 1997 legislation. Current 13 CFR 120.111 allows SBA

to assist an Eligible Passive Company to use loan proceeds to acquire

property to lease to an Operating Company. SBA is proposing to amend 13

CFR 120.111 to authorize SBA to provide financing to an Eligible

Passive Company which could use the proceeds to lease property to

multiple unrelated Operating Companies. This proposed change would make

the Eligible Passive Company provision consistent with the proposed

change to 13 CFR 120.801.

The 1996 legislation amended the Act with respect to the

amount of a Borrower's contribution to the financing of a 504 Project.

SBA is proposing to amend 13 CFR 120.910 of its regulations to require

the Borrower to contribute at least 15 percent of the total cost of the

504 Project if the Borrower (or Operating Company if the Borrower is an

Eligible Passive Company) has been in business for 2 years or less, or

if the Project is the acquisition, construction, conversion, or

expansion of a limited or single purpose building. The Borrower must

contribute at least 20 percent of the total cost of the Project if both

these conditions exist.

The 1996 legislation requires that not less than 50

percent of a Project's cost must be financed by a Third Party Lender if

the Borrower's contribution is made under the conditions described

above for proposed 13 CFR 120.910. This proposed revision of 13 CFR

120.920 implements that change.

The 1997 legislation amended the Act to permit a 504

Borrower to lease long term no more than 20 percent of a new 504

Project if the Borrower would immediately occupy no less than 60

percent of the property. To comply with the 1997 legislation, SBA is

proposing to amend 13 CFR parts 120.131 and 120.870 to authorize a

Borrower to lease long term up to 20 percent of the rentable space in a

504 Project to third parties when the Borrower will occupy at least 60

percent of the rentable space with plans to occupy another 20 percent

of the rentable space within 3 years. The present law allows a Borrower

in a 504 Project to lease up to 33 percent of a new facility if the

Borrower can show that it will need additional space within 3 years and

that it will fully use the facility within 10 years. Under the proposed

rule, the Borrower will have the option of showing that it will

ultimately use 80 percent of the rentable space within 3 years, and

that it plans to lease long term 20 percent of the space to others. The

effect of this change will be to allow a business to construct a

building in a good location without being compelled to show that it

will use all of the space. Thus, the proposed rule will alleviate the

present strict restrictions on the use of property.

13 CFR 120.862(b) sets forth specific public policy goals

a CDC may use to qualify a 504 Project or support an increased amount

of 504 financing. 13 CFR 120.862(b)(3) lists expanding Minority

Enterprise Development as one of the public policy goals. SBA is

proposing to amend 13 CFR 120.862(b)(3) to direct the reader to the

correct section in SBA's regulation designating the specific minority

groups to which the subsection applies. 13 CFR 120.862 (b)(7) lists as

one of the public policy goals the assistance of businesses affected by

Federal budget reductions. SBA is proposing to amend 13 CFR

120.862(b)(7) by clarifying that the public policy goal is to assist

any eligible small business in an area

[[Page 24754]]

affected by such reductions, not only those businesses which can show

that they were affected adversely by the budget reduction. Therefore,

if a geographic area has been adversely affected by Federal budget

reductions, SBA can assist a business located in that area or moving to

that area without showing that the particular business was affected.

The 1996 legislation requires SBA to charge the Borrower a

fee of not more than 0.9375 percent on the unpaid principal balance of

the loan as determined at 5-year anniversary intervals. SBA is amending

13 CFR 120.971 of its regulations to implement this change. In

addition, 13 CFR 120.971(a)(3) raises the minimum servicing fee from .5

percent to .625 percent.

SBA is proposing to insert a new Section 120.972 in 13 CFR

to implement the 1996 legislation which requires SBA to collect a one-

time fee equal to 50 basis points on the total participation in a

Project by a Third Party Lender when that Third Party Lender occupies a

senior credit position to that of SBA. In addition, under the proposed

regulation, SBA will collect an annual fee from each CDC equal to 0.125

percent of the outstanding principal balance of any Debenture

guaranteed by SBA after September 30, 1996. The CDC must pay the fee

from the servicing fees collected by the CDC and not from additional

fees imposed on the Borrower.

Currently, under 13 CFR 120.921(d), any future advance by

a Third Party Lender in excess of the outstanding balance and accrued

interest must be subordinated to the CDC/SBA lien unless the future

advance is to collect payments, maintain collateral, or protect the

Third Party Lender's lien position on the Third Party Loan. SBA has

been unable at times to realize the full benefit of its lien position,

despite its regulations requiring future advances to be subordinate to

the CDC/SBA lien.

Moreover, if a Third Party Lender wants to make additional capital

available to a 504 Borrower, it easily can do so through another loan.

SBA is proposing to revise 13 CFR 120.921(d) to state that the Third

Party Loan cannot be open-ended as to amount, and after completion of

the 504 Project, a Third Party Lender may only make a future advance

under the Third Party Loan to collect amounts due on the Third Party

Loan note, maintain collateral or protect its lien.

SBA also has been unable to realize the full benefit of

its lien position because of prepayment penalties, late fees, and

escalated interest after default due under the Third Party Loan.

Accordingly, SBA also proposes to add a new paragraph (e) to 13 CFR

120.921 that would state that the Third Party Lender's lien is

subordinate to the CDC/SBA lien with respect to prepayment penalties,

late fees, and escalated interest after default due under the Third

Party lien.

When a small business defaults on a Third Party Loan, SBA

may choose to assume the obligations of the Borrower. The 1996

legislation amended the Act to ensure that when SBA assumes such

obligation for Projects approved after September 30, 1996, it only will

pay the interest rate on the note in effect immediately prior to the

date of the Borrower's default. SBA is proposing to redesignate and

revise present paragraph (e) of Section 120.921 of 13 CFR to become new

paragraph (f) stating that SBA only will pay the interest rate in

effect immediately prior to the date of the Borrower's default with

respect to a Project approved after September 30, 1996.

SBA is proposing to amend 13 CFR 120.802 to clarify the

definition for Third Party Loan and 13 CFR 120.801(c)(3) to reflect

that definition.

Currently, Section 120.870(c)(1) of 13 CFR requires the

term of a lease of the Project premises to be at least equal to the

terms of the Debenture. However, this may not be necessary if the

Project is only machinery and equipment. Therefore, SBA proposes to

delete machinery and equipment from the definition to clarify that the

length of a lease for machinery and equipment is a credit issue.

Changes to CDC Closing Fees

Section 120.883 of 13 CFR sets forth administrative costs which may

be paid with the proceeds of a loan funded by a 504 Debenture rather

than out of the Borrower's own resources. Section 120.971 of 13 CFR

sets forth the fees that a CDC may charge a Borrower.

Throughout the history of the 504 Program, most of the services

required to prepare 504 loan documents and close a 504 loan have been

performed for CDCs, at CDC cost, by legal counsel, paralegals, and CDC

staff. The CDC has then charged its Borrower a fee at closing to

reimburse the CDC for these expenses (``CDC Closing Fee''). Although

this CDC Closing Fee reimburses the CDC for expenses the CDC pays to

its own lawyers, the Borrower is not considered to be paying a legal

fee, since the Borrower is not represented by CDC counsel. The Borrower

pays separately the legal fees of its legal counsel.

Under the 504 Program, loan proceeds may be used to pay eligible

Project costs and eligible administrative costs. Eligible Project costs

are costs directly attributable to the Project including professional

fees essential to the Project for services such as architecture,

engineering, and environmental studies. The Borrower's legal fees for

Project-related matters such as zoning, title searches, and recording

fees, as well as interest and points on the interim construction loan,

are eligible Project costs. The Borrower's legal fees associated with

the closing are not eligible Project costs.

Eligible administrative costs are amounts the Borrower pays for

services connected with closing, but not directly attributable to the

Project itself. These include SBA's guarantee fee, the CDC's processing

fee, and 504 closing agent fees. The Borrower's legal fees associated

with the closing are not eligible administrative costs. Until March 1,

1996, the CDC Closing Fee was an eligible administrative cost. By

regulation, the Borrower could pay the CDC Closing Fee out of the

proceeds of a 504 loan up to a maximum of $2,500. Since then, SBA has

not recognized the CDC Closing Fee as an eligible administrative cost,

and Borrowers must reimburse the CDC out of their own resources.

CDCs, Borrowers, and SBA share a common interest in minimizing

legal fees to reduce costs to the Borrower. During the period before

March 1, 1996, some in the 504 industry felt that SBA's regulation

influenced the market rate for legal fees and other miscellaneous

expenses associated with 504 Closings. They argued that attorney fees

charged CDCs by CDC counsel were maintained at an artificially high

level because the CDC Closing Fee was an eligible administrative cost

financed out of the loan proceeds. They further argued that the

reference in the regulation to a $2,500 limitation established a

minimum base for the attorney fees.

SBA received 15 comments concerning these issues during the comment

period following publication of its proposed rule changes in 60 FR

64356 on December 15, 1995. Most of them supported retaining the CDC

Closing Fee as an eligible administrative cost. SBA believed, however,

that legal expenses associated with the 504 Closing should be

determined by the competitive marketplace and that there was some merit

in the contention that the eligibility of the CDC Closing Fee as an

administrative cost resulted in higher attorney fees. Despite the

opposition expressed in most of the comments received, SBA decided to

exclude the

[[Page 24755]]

CDC Closing Fee from eligible administrative costs and eliminated the

$2,500 reference in its final rule published in 61 FR 3226, dated

January 31, 1996.

SBA expected that these regulatory changes would reduce attorney

fees. It also anticipated downward competitive pressure on such fees as

more attorneys became designated to perform expedited 504 loan

closings.

CDCs have been closing loans under the new rules for nearly 2

years. Approximately 140 attorneys are now enrolled as designated

closing attorneys, and more than 50 percent of all 504 loans close

under the expedited process. Yet fees associated with 504 closings

charged CDCs by CDC counsel do not appear to have decreased.

Legislation enacted since the rule became effective has imposed

additional fees upon Borrowers. Industry representatives indicate that

the combination of increased fees and the inability to pay the CDC

Closing Fee out of the Debenture proceeds has reduced access by small

businesses to the 504 Program. Because the fees now are not eligible

administrative costs, they must be paid by the Borrowers from other

resources. Not all Borrowers can afford to pay these costs without use

of the Debenture proceeds.

In an effort to assist its small business customers, SBA is

proposing to make CDC Closing Fees eligible administrative costs up to

a maximum of $2,500 per Closing.

Compliance With Executive Orders 12612, 12778, and 12866, the

Regulatory Flexibility Act (5 U.S.C. 601, et seq.), and the

Paperwork Reduction Act (44 U.S.C. Ch. 35)

SBA certifies that this proposed rule does not constitute a

significant rule within the meaning of Executive Order 12866, since it

is not likely to have an annual effect on the economy of $100 million

or more, result in a major increase in costs or prices, or have a

significant adverse effect on competition or the U.S. economy.

SBA certifies that this proposed rule will not have a significant

economic impact on a substantial number of small entities within the

meaning of the Regulatory Flexibility Act, 5 U.S.C. 601, et seq. Last

year, SBA made approximately four thousand 504 loans. Currently there

are approximately 300 CDCs, less than 15 of which are Premier CDCs.

While the 1997 legislation removes the limit on the number of CDCs that

can become Premier CDCs, SBA anticipates that, at most, only half of

the CDCs would be affected by this rule. Thus the changes to the

Program in the proposed rule, including the changes to the Closing Fee

provisions and the changes implementing P.L. 104-208 and P.L. 105-135

will not constitute a significant impact on a substantial number of

small businesses.

SBA certifies that this proposed rule does not impose any

additional reporting or recordkeeping requirements under the Paperwork

Reduction Act, 44 U.S.C. chapter 35.

For purposes of Executive Order 12612, SBA certifies that this

proposed rule has no federalism implications warranting preparation of

a Federalism Assessment.

For purposes of Executive Order 12778, SBA certifies that this

proposed rule is drafted, to the extent practicable, to accord with the

standards set forth in section 2 of that Order.

List of Subjects in 13 CFR Part 120

Loan programs--business, Small businesses.

Accordingly, pursuant to authority contained in section 5(b)(6) of

the Small Business Act (15 U.S.C. 634(b)(6)), SBA proposes to amend

part 120, chapter I, title 13, Code of Federal Regulations as follows:

PART 120--BUSINESS LOANS

1. The authority citation for Part 120 would continue to read as

follows:

Authority: 15 U.S.C. 634 (b)(6) and 636(a) and (h).

2. Amend Sec. 120.111 by revising the first sentence to read as

follows:

Sec. 120.111 What conditions must an Eligible Passive Company satisfy?

An Eligible Passive Company 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

for the conduct of the Operating Company's business (references to one

Operating Company include multiple Operating Companies, as applicable).

* * *

* * * * *

3. Amend Sec. 120.131(a) by adding a new sentence at the end to

read as follows:

Sec. 120.131 Leasing part of new construction or existing building to

another business.

(a) * * * (See Sec. 120.870(c) for an exception with respect to 504

Projects.)

* * * * *

4. Amend Sec. 120.801 by revising the first sentence of paragraph

(a) and paragraph (c)(3) to read as follows:

Sec. 120.801 How is a 504 Project financed?

(a) One or more small businesses may apply for 504 financing

through a CDC serving the area in which the 504 Project is located. * *

*

* * * * *

(c) * * *

(3) Third Party Loan comprising the balance of the financing,

collateralized by a first lien on the Project property (see section

120.920).

* * * * *

5. Amend Sec. 120.802 by revising the definition of Third Party

Loan to read as follows:

Sec. 120.802 Definitions.

* * * * *

Third Party Loan is a loan from a commercial or private lender,

investor, or Federal (non-SBA), State or local government source that

is part of the Project financing.

* * * * *

6. Amend Sec. 120.862 by revising the parenthetical clause in

paragraph (b)(3) and by revising paragraph (b)(7) to read as follows:

Sec. 120.862 Other economic development objectives.

* * * * *

(b) Public Policy goals: * * *

(3) * * * (See Sec. 124.105(b) for minority groups who qualify for

this description.);

* * * * *

(7) Assisting businesses in or moving to areas affected by Federal

budget reductions, including base closings, either because of the loss

of Federal contracts in the area or the reduction in revenues in the

area due to a decreased Federal presence.

7. Amend Sec. 120.870 by revising paragraph (a)(1) and adding a new

paragraph (c) to read as follows:

Sec. 120.870 Leasing Project Property.

(a) * * *

(1) The remaining term of the lease, including options to renew,

exercisable solely by the lessee, equals or exceeds the term of the

Debenture;

* * * * *

(c ) If the Project is for new construction, a Borrower may lease

long term no more than 20 percent of the rentable property in the

Project to one or more tenants if the Borrower immediately occupies not

less than 60 percent of the rentable property with plans to occupy the

remaining 20 percent within 3 years.

8. Revise Sec. 120.883 to read as follows:

[[Page 24756]]

Sec. 120.883 Eligible administrative costs for 504 loans.

The following administrative costs are not part of Project costs,

but may be paid with the proceeds of the 504 loan and the Debenture

(see Sec. 120.971):

(a) SBA guarantee fee;

(b) Funding fee (to cover the cost of a public issuance of

securities and the Trustee);

(c) CDC processing fee;

(d) Borrower's out-of-pocket costs associated with the closing of

the 504 loan (other than legal fees);

(e) CDC Closing Fee (see Sec. 120.971(a)(2)) up to a maximum of

$2,500; and

(f) Underwriters' fee.

9. Revise Sec. 120.910 to read as follows:

Sec. 120.910 How much must the Borrower contribute?

(a) The Borrower must contribute to the Project cash (or property

acceptable to SBA obtained with the cash) or land (that is part of the

Project Property), in an amount equal to the following percentage of

the Project cost, exclusive of administrative cost:

(1) At least 15 percent, if the Borrower (or Operating Company if

the Borrower is an Eligible Passive Company) has been in operation for

2 years or less;

(2) At least 15 percent, if the Project involves the acquisition,

construction, conversion, or expansion of a limited or single purpose

building or structure;

(3) At least 20 percent, if the Project involves both of the

conditions described in paragraphs (a) (1) and (2) of this section; or

(4) At least 10 percent, in all other circumstances.

(b) The source of the contribution may be a CDC or any other source

except an SBA business loan program (see Sec. 120.913 for SBIC

exception).

10. Revise Sec. 120.920 to read as follows:

Sec. 120.920 Required participation by the Third Party Lender.

(a) Amount of Third Party Loans. A Project financing must include

one or more Third Party Loans totaling at least as much as the 504

loan. However, the Third Party Loans must total at least 50 percent of

the total cost of the Project if:

(1) The Borrower (or Operating Company, if the Borrower is an

Eligible Passive Company) has been in operation for 2 years or less, or

(2) The Project is for the acquisition, construction, conversion,

or expansion of a limited or single purpose asset.

(b) Third Party Loan collateral. Third Party Loans usually are

collateralized by a first lien on the Project property. They cannot be

guaranteed by SBA.

11. In Sec. 120.921 revise and redesignate paragraphs (d) and (e)

as paragraphs (e) and (f) and add a new paragraph (d) to read as

follows:

Sec. 120.921 Terms of Third Party Loans.

* * * * *

(d) Future advances. The Third Party Loan must not be open-ended.

After completion of the Project, the Third Party Lender may not make

future advances under the Third Party Loan except expenditures to

collect amounts due the Third Party Loan notes, maintain collateral,

and protect the Third Party Lender's lien position on the Third Party

Loan.

(e) Subordination. The Third Party Lender's lien will be

subordinate to the CDC/SBA lien as to any prepayment penalties, late

fees, and increased default interest due under the Third Party Loan.

(f) Escalation upon default. A Third-Party Lender may not escalate

the rate of interest upon default to a rate greater than the maximum

rate set forth in paragraph (b) of this section. With respect to any

Project approved after September 30, 1996, SBA will only pay the

interest rate on the note in effect prior to the date of the Borrower's

default.

12. Amend Sec. 120.971 by revising the first sentence of paragraph

(a)(2) and paragraphs (a)(3), and (d)(2) to read as follows:

Sec. 120.971 Allowable fees paid by Borrower.

(a) * * *

(2) Closing fee. The CDC may charge a reasonable closing fee in an

amount sufficient to reimburse it for the expenses of its in-house or

outside legal counsel, and other miscellaneous closing costs (CDC

Closing Fee). * * *

(3) Servicing fee. The CDC will charge a monthly servicing fee of

not less than 0.625 percent per annum nor more than 2 percent per annum

on the unpaid balance of the loan as determined at 5-year anniversary

intervals. A servicing fee in excess of 1.5 percent in a Rural Area and

1 percent everywhere else requires SBA's prior written approval, based

on evidence of substantial need. The servicing fee may be paid only

from loan payments received. The fees may be accrued without interest

and collected from the CSA when the payments are made.

* * * * *

(d) * * *

(2) For loans approved by SBA after September 30, 1996, SBA charges

a fee of not more than 0.9375 percent per annum on the unpaid principal

balance of the loan as determined at 5-year anniversary intervals.

* * * * *

13. In part 120 redesignate Sec. 120.972 as Sec. 120.973, and add a

new Sec. 120.972 to read as follows:

Sec. 120.972 Third Party Lender participation fee and Development

company fee.

(a) Participation fee. For loans approved by SBA after September

30, 1996, SBA must collect a one-time fee from the Third Party Lender

equal to 50 basis points on its total participation in a Project when

the Third Party Lender occupies a senior credit position to SBA in the

project.

(b) Development company fee. For loans approved by SBA after

September 30, 1996, SBA must collect an annual fee from the CDC equal

to 0.125 percent of the outstanding principal balance of the debenture.

The fee must be paid from the servicing fees collected by the CDC and

cannot be paid from any additional fees imposed on the Borrowers.

Dated: April 28, 1998.

Aida Alvarez,

Administrator.

[FR Doc. 98-11910 Filed 5-4-98; 8:45 am]

BILLING CODE 8025-01-P