504 and 7(a) Loan Programs Updates, 12633-12646 [2013-04221]

Agencies

• SMALL BUSINESS ADMINISTRATION

[Federal Register Volume 78, Number 37 (Monday, February 25, 2013)]
[Proposed Rules]
[Pages 12633-12646]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2013-04221]


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Proposed Rules
                                                Federal Register
________________________________________________________________________

This section of the FEDERAL REGISTER contains notices to the public of 
the proposed issuance of rules and regulations. The purpose of these 
notices is to give interested persons an opportunity to participate in 
the rule making prior to the adoption of the final rules.

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Federal Register / Vol. 78, No. 37 / Monday, February 25, 2013 / 
Proposed Rules

[[Page 12633]]



SMALL BUSINESS ADMINISTRATION

13 CFR Parts 120 and 121

RIN 3245-AG04


504 and 7(a) Loan Programs Updates

AGENCY: U.S. Small Business Administration.

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: The U.S. Small Business Administration (``SBA'') has 
determined that changing conditions in the American economy and 
persistent high levels of unemployment compel the agency to seek ways 
to improve access to its two flagship business lending programs: the 
504 Loan Program and the 7(a) Loan Program. The purpose of this 
proposed rulemaking is to reinvigorate these programs as vital tools 
for creating and preserving American jobs. SBA proposes to strip away 
regulatory restrictions that detract from the 504 Loan Program's core 
job creation mission as well as the 7(a) Loan Program's positive job 
creation impact on the American economy. The 504 Loan Program and 7(a) 
Loan Program are SBA's two primary business loan programs authorized 
under the Small Business Investment Act of 1958 and the Small Business 
Act, respectively. This proposed rule will enhance job creation through 
increasing eligibility for loans under SBA's business loan programs, 
including its Microloan Program, and by modifying certain program 
participant requirements applicable to the 504 Loan Program. In 
addition, SBA proposes to revise Certified Development Company (CDC) 
operational requirements to clarify certain existing regulations.

DATES: SBA must receive comments to this proposed rule on or before 
April 26, 2013.

ADDRESSES: You may submit comments, identified by RIN: 3245-AG04 by any 
of the following methods:
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.
     Email: ocareg2013@sba.gov. Include RIN 3245-AG04 in the 
subject line of the message.
     Mail: Patrick Kelley, Deputy Associate Administrator, 
Attention: Linda Reilly, Chief, 504 Program Branch, Office of Capital 
Access, U.S. Small Business Administration, 409 Third Street SW., 
Washington, DC 20416.
     Hand Delivery/Courier: Patrick Kelley, Deputy Associate 
Administrator, Attention: Linda Reilly, Chief, 504 Program Branch, 
Office of Capital Access, U.S. Small Business Administration, 409 Third 
Street SW., Washington, DC 20416.
    SBA will post all comments on www.regulations.gov. If you wish to 
submit confidential business information (CBI) as defined in the User 
Notice at www.regulations.gov, please submit the information to Patrick 
Kelley, Deputy Associate Administrator, Attention: Linda Reilly, Chief, 
504 Program Branch, Office of Capital Access, U.S. Small Business 
Administration, 409 Third Street SW., Washington, DC 20416, or send an 
email to ocareg2013@sba.gov. Highlight the information that you 
consider to be CBI and explain why you believe SBA should hold this 
information as confidential. SBA will review the information and make 
the final determination whether it will publish the information.

FOR FURTHER INFORMATION CONTACT: Linda Reilly, Chief, 504 Program 
Branch, Office of Financial Assistance, Small Business Administration, 
409 3rd Street SW., Washington, DC 20416; telephone 202-205-9949.

SUPPLEMENTARY INFORMATION:

I. Background Information

    Executive Order 13563 directs agencies to ensure that regulations 
are accessible, consistent, written in plain language, and easy to 
understand in order to foster economic growth and job creation. 
Executive Order 13563 provides that our regulatory system ``must 
identify and use the best, most innovative, and least burdensome tools 
for achieving regulatory ends.'' (emphasis added). Executive Order 
13563 further provides that ``[t]o facilitate the periodic review of 
existing significant regulations, agencies shall consider how best to 
promote retrospective analysis of rules that may be outmoded, 
ineffective, insufficient, or excessively burdensome, and to modify, 
streamline, expand, or repeal them in accordance with what has been 
learned.'' (emphasis added). SBA has reviewed its regulations with 
regard to the loan programs and is proposing a number of amendments and 
revisions to accomplish this goal.
    SBA's primary business loan programs are the 504 Loan Program (the 
``504 Loan Program''), authorized pursuant to Title V of the Small 
Business Investment Act of 1958, 15 U.S.C. 695 et seq., and the 7(a) 
Loan Program (the ``7(a) Loan Program'') authorized pursuant to Section 
7(a) of the Small Business Act, 15 U.S.C. 631 et seq. (collectively 
referred to as the ``504 and 7(a) Loan Programs''). A description of 
each loan program is set forth below.

A. SBA's 504 Loan Program

    The 504 Loan Program is an SBA financing program established to 
target companies in their growth cycle to create jobs, expand the tax 
base, and improve American communities. Specifically, the core mission 
of the 504 Loan Program is to provide long-term fixed asset financing 
to small businesses for the purchase or improvement of land, buildings, 
and major equipment purchases, in an effort to facilitate the creation 
of jobs and local economic development.
    Under the 504 Loan Program, loans are made to small business 
applicants by Certified Development Companies (``CDCs''), which are 
SBA's community-based partners for providing 504 Loans. With the 
exception of several for-profit CDCs grandfathered into the 504 Loan 
Program, a CDC is a nonprofit corporation that promotes economic 
development within its community through 504 Loans. CDCs are certified 
and regulated by the SBA, and work with SBA and participating lenders 
(typically banks) to provide financing to small businesses, which in 
turn, accomplishes the goal of community economic development. There 
are over 260 CDCs nationwide each with a defined Area of Operations 
covering a specific geographic area. The Area of Operation for most 
CDCs is the state in which they are incorporated.
    Transactions under the 504 Loan Program are typically structured 
with a CDC providing 40% of the total project costs (with SBA's 
guarantee assistance),

[[Page 12634]]

a participating lender covering up to 50% of the total project costs, 
and the borrower contributing 10% of the project costs. Under certain 
circumstances, a borrower may be required to contribute up to 20% of 
the total project costs.
    In sum, the 504 Loan Program is an economic development tool and 
its success is measured, in large part, by the number of jobs it 
preserves and creates. In FY 2012, the agency made 7,047 loans through 
the 504 Loan Program, for a total volume of $4.4 billion, which led to 
the creation and/or retention of almost 80,000 jobs. SBA estimates that 
the proposed regulation revisions, set forth in detail below, will 
result in approximately 140,000 additional jobs created/retained over a 
five-year period. These additional jobs created/retained are based on 
an estimated 47,000 loans being made between FY 2013 and FY 2017, with 
an estimated total dollar volume of almost $30 billion and the 
creation/retention of over 500,000 jobs over the five-year period. The 
changes proposed primarily with regard to the Personal Resources Test 
and affiliation will increase the number of eligible borrowers.

B. SBA's 7(a) Loan Program

    The 7(a) Loan Program's main purpose is to help eligible small 
businesses obtain credit when they cannot obtain ``credit elsewhere.'' 
In addition, the agency recognizes that the 7(a) Loan Program is also 
an important engine for job creation. The 7(a) Loan Program provides 
financing for general business purposes through the agency's guaranty 
of a loan made by an approved lender. Currently, there are 
approximately 4,500 lenders participating in the 7(a) Loan Program.
    Below is a summary of the proposed changes to these business loan 
programs. The agency requests comments on all of the proposed 
regulatory revisions in this proposed rule, and on any related issues 
affecting the 7(a) Loan Program or the 504 Loan Program. SBA's intent 
is to revitalize the use of both loan programs as an engine of job 
retention and growth in an effort to use ``the best, most innovative, 
and least burdensome tools for achieving regulatory ends * * * and seek 
to improve, the actual results of regulatory requirements'' in 
accordance with Executive Order 13563.

II. Summary of Proposed Business Loan Program Changes

    Though SBA's business loan programs differ in mission and focus, 
these loan programs share fundamental eligibility criteria and 
overlapping objectives. The goal of the proposed rule is to 
reinvigorate the business loan programs by eliminating unnecessary 
compliance burdens and loan eligibility restrictions in an effort to 
make necessary adjustments to increase lender accessibility without 
sacrificing program integrity. The major changes that SBA is proposing 
are described below, including changes relating to affiliation 
principles, the personal resources test, the 9-month rule for the 504 
Loan Program, and CDC operational and organizational requirements. 
Additional changes are described in the section-by-section analysis.

A. Affiliation as Applied to the Business Loan Programs

    Under SBA's regulations, applicants for an SBA loan must be small 
under SBA's size requirements (including affiliates) to be eligible for 
an SBA business loan. 13 CFR 120.100. When an entity is determined to 
be affiliated with an applicant, the entity's receipts and employees 
are added to those of the applicant for purposes of determining its 
size. Thus, certain businesses are deemed to be ineligible for 
assistance because they are not deemed to be ``small'' for program 
purposes by virtue of their combined size with affiliated entities.
    SBA's regulations, at Sec.  121.103, set forth the agency's 
principles of affiliation. Generally, affiliation exists when one 
business controls or has the power to control another or when a third 
party (or parties) controls or has the power to control both 
businesses. Control may arise through ownership, management, or other 
relationships or interactions between the parties. Affiliation is an 
important issue when determining size because SBA counts the receipts, 
employees, or other measure of the business, for all of a small 
business' domestic and foreign affiliates, regardless of whether the 
affiliates are organized for profit (13 CFR 121.103(a)(6)). SBA's 
affiliation rules generally apply to all Federal programs for which a 
business must qualify as ``small,'' including SBA's Government 
Contracting or Business Development programs, business loan programs 
and grant programs. Therefore, applicants for financing under the 504 
Loan Program, 7(a) Loan Program or Microloan Program must qualify as 
``small businesses'' taking into consideration the employees, receipts, 
and other measures of business of the applicant and all of the 
applicant's affiliates.
    SBA believes that, in general, most of the principles of 
affiliation set forth in Sec.  121.103 appropriately apply to the 
agency's business loan programs. However, SBA believes that certain 
affiliation principles--such as those concerning newly organized 
concerns--are not applicable to the 504 and 7(a) Loan Programs or the 
Microloan Program because assisting in the creation of new small 
businesses serves the purpose of the business loan programs. In 
addition, SBA is seeking to create a simple, bright-line test for 
business loan program applicants when determining eligibility with 
respect to size and affiliation. By eliminating or modifying certain 
affiliation principles, this proposed rule would also significantly 
reduce the burden on applicants of providing affiliation documentation. 
As described below, SBA is proposing to add a new Sec.  121.302 to 
identify the principles of affiliation that should apply to the 
business loan programs in place of the affiliation principles set forth 
in Sec.  121.103, and invites comments on these proposed changes.
    With respect to determining affiliation based on ownership, the 
following principles currently apply to the business loan programs: (1) 
If the business concern's stock is widely held and no single block of 
stock is large as compared to others, the board of directors and Chief 
Executive Officer or President is deemed to have the power to control 
the business, absent evidence showing otherwise; (2) if two or more 
persons (including any individual, concern or other entity) each owns, 
controls or has the power to control less than 50% of the concern's 
voting stock, and the blocks of stock are equal or approximately equal 
in size and the blocks of stock are large in the aggregate as compared 
with any other stock holding, SBA presumes that each person controls or 
has the power to control the business concern whose size is at issue; 
or (3) if a person (including any individual, concern or other entity) 
owns, or has the power to control, 50 percent or more of a concern's 
voting stock, or a block of voting stock which is large compared to 
other outstanding blocks of voting stock, such person controls or has 
the power to control the business concern. It is also important to note 
that SBA's current affiliation rules (Sec.  121.103(a)(3)) may find 
affiliation based on ``affirmative control'' (e.g., owning more than 
50% of the voting stock of a company) as well as ``negative control'' 
(e.g., owning less than 50% but still having the ability to block 
votes).
    SBA is proposing to amend the principles described above for 
affiliation based on ownership in a manner similar to changes recently 
proposed by SBA for the Small Business Innovation Research

[[Page 12635]]

and Small Business Technology Transfer programs (77 FR 28520, May 15, 
2012). Under these proposed changes, SBA would deem the Chief Executive 
Officer (CEO) or President of the concern (or other officers, managing 
members, partners, or directors who control the management of the 
concern) to control the concern when no one person owns or has the 
power to control more than 50% of the voting equity of the concern. SBA 
believes that for purposes of the agency's business loan programs, 
control in this situation would rest with the managing parties 
identified above since it is those parties that are truly running the 
concern. If one person does own or has the power to control more than 
50% of the voting equity of the concern, that person is in control of 
the concern for purposes of determining affiliation. In addition, if 
two or more persons collectively own or have the power to control more 
than 50% of the voting equity of two or more concerns (the ``collective 
owners''), then there would be affiliation between such concerns and 
between each concern and each collective owner. In addition, in this 
proposed rule, SBA refers to 50% ownership or equity without 
designating that it is ``stock'' ownership because not all business 
loan applicants are corporations with ownership determined through 
stock issuance. SBA is also proposing to not consider ``negative 
control,'' by itself, as a factor in determining affiliation.
    SBA requests comments on this proposed rule as it relates to 
business loan applicants where no person owns a majority of the 
applicant, and whether SBA should: (1) Retain the current affiliation 
rule with respect to minority holdings and, if so, whether it should 
set forth a specific threshold by which it will find control and 
therefore affiliation (e.g., if a person owns 33% or more of the 
company) in order to create a bright-line test for applicants; (2) find 
affiliation, as proposed, if two or more persons or concerns 
collectively own more than 50% of the applicant, and the same persons 
or concerns collectively own more than 50% of any other company or 
entity; or (3) implement a rule setting forth both options (1) and (2) 
above.
    In addition to incorporating the above principles of affiliation 
based on ownership, SBA is proposing to incorporate in Sec.  121.302(c) 
and (e), respectively, the existing affiliation principles currently 
contained in Sec.  121.103(c) (Affiliation arising under stock options, 
convertible securities, and agreements to merge) and Sec.  121.103(i) 
(Affiliation based on franchise and license agreements). SBA is also 
proposing to incorporate in Sec.  121.302(d), with slight 
modifications, the existing affiliation principles currently contained 
in Sec.  121.103(e) (Affiliation based on common management).
    In addition to the above proposed change, SBA proposes changing 
current affiliation principles relating to the following three areas: 
identity of interest; newly organized concerns; and joint ventures. 
First, with respect to affiliation based on identity of interest, SBA 
proposes to not apply the current affiliation principle relating to 
identity of interest set forth in Sec.  121.103(f) to the 504 Loan 
Program, the 7(a) Loan Program or the Microloan Program. Affiliation 
through identity of interest often is found between business partners, 
family members, and employers. SBA is aware that an applicant may have 
relationships with former employers, business partners, friends, or 
family members which can be important to the business success of the 
applicant. These relationships often strengthen the creditworthiness of 
the applicant by providing the applicant with more resources from which 
to draw, thus lowering taxpayer risk while increasing the job creation 
and small business growth missions of the business loan programs. It is 
the agency's view that these relationships are common and, in the 
context of the business loan programs, should not prevent an applicant 
from independently operating and growing a business and creating jobs. 
Moreover, small businesses would have less of a financial incentive to 
use family members or former employees as business ``fronts'' to obtain 
a business loan than to obtain a grant or bid on a contract under a 
government set-aside program. Businesses would appear to have little 
incentive to incur debt through the use of such tactics because, unlike 
a grant or contract, the debt must eventually be repaid. Weighing all 
of these factors, the agency proposes to end application of the 
identity of interest affiliation rule to the business loan programs; 
however, it strongly encourages comment on this proposal especially as 
it relates to potential threats to business loan program integrity.
    Second, with respect to affiliation based on a newly organized 
concern, SBA proposes to not apply the current affiliation principle 
relating to newly organized concerns set forth in Sec.  121.103(g) to 
the 504 Loan Program, the 7(a) Loan Program or the Microloan Program. 
The agency proposes this change for substantially the same reasons it 
is proposing the change related to identity of ownership discussed 
above. If employees of a former employer form a new business and the 
former employer does not have ownership control of the new business, 
SBA believes that for purposes of the business loan programs the former 
employees will generally have sufficient independence and control of 
the newly formed business to not be affiliated with the former 
employer. The newly organized concern principle is needed in the 
agency's grant and contracting programs to prevent large companies from 
misrepresenting themselves as small through a shell company in order to 
obtain a grant or lucrative government contract intended as a small 
business set aside. However, the principle is not necessary in the 
business loan programs because larger companies have greater access to 
private sector capital sources than small businesses and would have 
little need to form a new concern to obtain a government loan. Thus, 
the agency is proposing to exempt agency business loan program 
applicants from application of the affiliation based on newly organized 
concern rule.
    Finally, with respect to affiliation based on joint ventures, SBA 
proposes to not apply the current affiliation principle relating to 
affiliation based on joint ventures set forth in Sec.  121.103(h) to 
the 504 Loan Program, the 7(a) Loan Program or the Microloan Program. 
Agency records indicate that applicants for assistance under agency 
business loan programs are rarely, if ever, joint ventures and, 
therefore, this provision is unnecessary for the business loan 
programs. This proposed change is being made in the interest of 
streamlining and simplifying business loan program rules, and to 
provide bright line eligibility criteria regarding affiliation 
determinations for the business loan programs.
    In conjunction with proposing the above revisions to 504 Loan 
Program regulations to expand program accessibility, streamline 
complicated processes, and minimize burdens to applicants and lenders, 
SBA seeks to ensure program integrity and maintain proper oversight 
through the following means. First, to assist in ensuring compliance 
with the affiliation principles, SBA proposes to require applicants to 
sign an affidavit certifying that all persons affiliated with the 
applicant have been identified in the affidavit. It is the agency's 
view that applicants are expected to know and disclose these persons 
and requiring this disclosure under sworn statement to the Federal 
government should deter applicants from omitting important

[[Page 12636]]

information necessary for determining compliance with the applicable 
size requirements. An affidavit on affiliate certifications would 
enable participant lenders to improve consistency and would also 
expedite SBA's review of the size eligibility of potential applicants. 
Completing the affidavit to document affiliated business owners of 50% 
or less would be less burdensome on applicants than having to submit 
tax documents or financial statements. In fact, SBA estimates that the 
proposed revision would reduce the burden on participants in both loan 
programs (both borrowers and lenders) by a total of 26,402 hours and 
result in savings totaling $700,777. Based on estimates using FY 2012 
loan approvals as a base, the annual savings to borrowers for both 
programs combined is estimated at $700,000 and $750,000 annually. 
Similarly, SBA estimates that the proposed revision will reduce burden 
to the government by a total of 2,666 hours and result in savings 
totaling $78,085. Based on estimates using FY 2012 approvals as a base, 
this burden reduction in loan review time combined for both loan 
programs, is estimated at between $80,000 and $100,000 annually. Thus, 
not only would the affidavit on affiliates be a control mechanism to 
ensure against abuse of SBA's guaranty and simplify and reduce 
potential mistakes in size standard decisions, but it would also be a 
critical time and cost saving measure, as demonstrated by the above 
data.
    Second, and notwithstanding the agency's goal to provide bright 
line eligibility criteria regarding affiliation determinations for the 
business loan programs, the agency realizes that egregious cases of 
large entities benefiting from a small business loan program can 
threaten program integrity and public support. Thus, the agency 
proposes to add a provision applicable only to the business loan 
programs which would give the agency the discretion to prevent business 
loan program participation of an applicant if, after consideration of 
the totality of the circumstances, it determines that affiliation 
exists rendering the applicant ineligible, even when no single factor 
is sufficient to constitute affiliation. For example, a finding of 
affiliation may be appropriate if an applicant lists a minor child as a 
majority owner and CEO of a concern, but a parent of the child actually 
owns or has the power to control the business. The Agency would look 
beyond the fiction of the child's ownership and position to determine 
who actually controls the business, and consider the affiliates of the 
party in control.
    The agency does not expect to use this discretionary provision 
often and intends to apply it only in egregious cases, one being the 
example identified above, that might threaten business loan program 
integrity or viability. SBA encourages comments and suggestions 
regarding this proposal and, specifically, regarding additional 
standards to prevent loans to ineligible applicants, which could 
endanger the viability of the loan programs.
    In sum, the elimination of unnecessary affiliation tests from the 
business loan programs would expand program eligibility to 
independently owned and controlled small businesses that would have 
previously been considered ineligible. This is illustrated by the fact 
that the SBA 504 loan program has not exhausted its program authority 
in the last 6 years. From 2006 through 2011, approximately 32% of 
authorized funds have gone unused. In 2012, SBA had left unused 41% of 
its 504 loan program authorized funds. Therefore, SBA recognizes the 
need to expand access to the program to more small businesses.
    Moreover, as a result, this proposed change would also 
significantly reduce the excessive burden that is imposed on all 
eligible small businesses and participating lenders to provide 
documentation for numerous affiliates to make size evaluations. Under 
the current regulations for both loan programs, SBA estimates that 
borrowers and lenders expend $7,274,657 and spend 274,448 hours on 
providing the documentation for numerous affiliates for SBA to make 
size determinations. Under the proposed revisions, the SBA estimates 
that lenders and borrowers would expend $6,573,880 and spend 248,046 
hours on providing the necessary documents to SBA. Along those same 
lines, under current regulations, SBA estimates that the Agency expends 
approximately $1,567,246 and 53,549 hours on reviewing all of the 
documents in making size eligibility determinations. Under the proposed 
revisions, the SBA estimates expending $1,489,161 and 50,883 hours on 
reviewing the necessary documents.
    By mitigating the burdens imposed by the current regulations and 
streamlining processes, the proposed rule would expand eligibility for 
the 504 and 7(a) Loan Programs, as well as SBA's Microloan Program 
authorized under section 7(m) of the Small Business Act (the 
``Microloan Program''), by redefining the permitted affiliations for 
borrowers for purposes of determining the applicant's size, but 
balancing that expansion by requiring an affidavit as to ownership and 
including a discretionary provision allowing the SBA to analyze the 
``totality of the circumstances'' in egregious cases.

B. The Personal Resources Test

    An applicant is ineligible for financing under the agency's 
business loan programs if it can obtain credit elsewhere. A brief 
history surrounding the current regulation is instructive here. The 
initial version of Section 7(a) of the Small Business Act authorized 
SBA to make loans to small businesses with the restriction that ``no 
financial assistance shall be extended * * * unless the financial 
assistance applied for is not otherwise available on reasonable 
terms.'' (Pub. L. 85-536, 72 Stat 388 (1958)). During the initial 
implementation of the 7(a) Loan Program in 1958, the agency interpreted 
the financial resources test to include the requirement that the funds 
applied for by the applicant ``not appear to be obtainable without 
undue hardship through utilization of the personal credit or resources 
of the owner, partners, management, or principal shareholders of the 
applicant.'' (23 FR 10513, December 31, 1958). Thus, the agency 
required documentation that obtaining the needed financing through use 
of personal credit or personal resources would create undue hardship 
before the applicant would be eligible for agency assisted financing.
    As early as 1971, the agency received feedback from the U.S. 
General Accounting Office that loans or guarantees were being made on 
behalf of applicants in greater amounts than were necessary considering 
the personal credit and personal resources of those applicants. The 
recommendation at that time was that the agency create criteria that 
would specify to agency loan specialists when a loan should be 
disapproved or agency participation reduced because the personal 
resources or credit of principals were substantial enough to be used 
without undue hardship of the principals.
    In response, SBA began to provide strict criteria including 
procedures for ``careful review'' of any person with 20% ownership in 
the company or engaged in active management of the company (and in 
tandem excusing from review persons with less than 5% ownership 
interest in the applicant with no active management role with the 
applicant). Still, there was no bright-line established for what would 
presumptively constitute an ``undue hardship'' or what contribution of 
personal resources was appropriate. For

[[Page 12637]]

example, in the agency's standard operating procedures effective in 
1985, guidance to loan specialists for the 7(a) Loan Program stated 
that ``reasonable utilization of personal assets'' of applicant 
principals applied to each principal's family as well, with exemptions 
for cash surrender of life insurance and IRAs, reasonable education 
expenses, and an additional exemption for each family equal to $50,000 
or 25% of the loan amount, whichever was greater. (SBA SOP 50 10 2A 
(page 38, effective September 16, 1985) (available upon request.)) 
There was also guidance regarding the requirement that certain family 
real estate could be counted as personal resources to be used in lieu 
of program assistance (e.g., ``refinancing or sale of real estate may 
be considered when a principal owner has funds readily available 
through sale or refinancing that would provide a majority of the loan 
request'' though owner occupied residences were generally exempted and 
there was an exemption when ``these general rules appear to work as a 
hardship due to the circumstances of the individual case.'') (SBA SOP 
50 10 2A (page 39, effective September 16, 1985) (available upon 
request.)) This history demonstrates the difficulty the agency had in 
establishing clear standards for determining when the use of personal 
resources would create undue hardship to the principals of a business. 
In 1996, the agency revised its regulations in an effort to create a 
more objective standard by quantifying the amount of personal resources 
that must be injected into the business. (61 FR 3226, January 31, 1996)
    While there have been numerous amendments to Section 7(a), the 
credit elsewhere restriction has remained, with slight modifications. 
For instance, the phrase ``credit elsewhere'' was introduced in 1981 
when the provision was changed to read that ``[n]o financial assistance 
shall be extended pursuant to this subsection if the applicant can 
obtain credit elsewhere.'' (The Small Business Budget Reconciliation 
and Loan Consolidation/Improvement Act of 1981, Pub. L. 97-35, title 
XIX, section 1902, 95 Stat. 767 (1981)). A definition for ``credit 
elsewhere'' was added at the same time. Section 3(h) of the Small 
Business Act defines ``credit elsewhere'' as the ``availability of 
credit from non-Federal sources on reasonable terms and conditions 
taking into consideration the prevailing rates and terms in the 
community in or near where the concern transacts business, or the 
homeowner resides, for similar purposes and periods of time.'' 15 
U.S.C. 632(h).
    Similarly, for the 504 Loan Program, section 503(b)(2) of the Small 
Business Investment Act of 1958 authorizes financing of applicants only 
when ``necessary funds for making such loans are not available to such 
companies from private sources on reasonable terms.'' Historically, to 
meet this requirement, the agency verified that private financing on 
reasonable terms was not available to the 504 applicant, but did not 
require a review of the personal resources of the applicant's 
principals and owners. As late as 1993, the agency issued standard 
operating procedures that instructed loan specialists that the 
availability of personal resources would not usually disqualify an 
applicant from receiving assistance under the 504 Loan Program because 
the primary focus of that program was economic development (job 
creation). (SBA SOP 50 22 3A (page 58, effective December 30, 1993) 
(available upon request)). In 1995, however, SBA published proposed 
regulations explaining that the agency had come to the conclusion that 
``there is no difference between the business loan programs regarding 
evidence of need [and that] SBA will consider the personal wealth and 
resources of the principals and owners in determining an applicant's 
need for SBA financial assistance in all business loan programs, and 
SBA may require the principals and owners of the applicant to use their 
personal resources before SBA will grant financial assistance'' (60 FR 
64362, December 15, 1995). This change was adopted as final in 1996, 
and the 504 Loan Program was made subject to the same personal 
resources test as the 7(a) Loan Program. (61 FR 3226, January 31, 
1996).
    Under the current personal resources test for the 7(a) and 504 Loan 
Programs, an assessment is required of the liquid assets of each owner 
of 20 percent or more of the equity of the applicant company to 
determine the overall dollar value of personal resources that do not 
have to be injected into the business (referred to as the 
``exemption''). The current allowable exemption is determined on the 
basis of the ``total financing package.'' The total financing package 
includes any SBA loans, together with any other loans, equity 
injection, or business funds used or arranged for at the same general 
time for the same project as the SBA loan. If the total financing 
package:
     Is $250,000 or less, the exemption is two times the total 
financing package or $100,000, whichever is greater;
     Is between $250,001 and $500,000, the exemption is one and 
one-half times the total financing package or $500,000, whichever is 
greater; or
     Exceeds $500,000, the exemption equals the total financing 
package or $750,000, whichever is greater.

Once the exemption is determined, it is subtracted from the liquid 
assets. If the result is positive, that amount must be injected into 
the project.
    The agency is proposing to eliminate this personal resources test 
from the regulations. SBA has become concerned, that even borrowers 
whose principals have significant personal resources may be unable to 
obtain long-term fixed asset financing from private sources at 
reasonable rates. The agency is now questioning whether the existence 
of personal resources directly correlates to the ability to obtain 
commercial credit on reasonable terms and is, therefore, rethinking the 
appropriateness of using personal resources as an indirect means of 
determining whether credit is available from private sources. The 
agency believes it is part of the agency's core mission regarding the 
assistance of small businesses to increase access to capital and that a 
personal resource test does not promote access to capital as it 
unnecessarily restricts the pool of potential investors for small 
businesses that participate in both loan programs. The agency notes 
that if the personal resources test is eliminated, more robust 
borrowers will be eligible to participate in the 504 and 7(a) Loan 
Programs, The agency is proposing to eliminate this personal resources 
test from the regulations thereby mitigating risk to the agency's 
portfolio of loans while facilitating job growth. Based on the agency's 
records, the number of loan approvals dropped by 42% in 1997, the year 
after the personal resource test was first instituted for the 504 Loan 
Program. As the recession has limited access to capital, eliminating 
the personal resource test would assist small businesses in attracting 
more types of investors.
    For reasons set forth above, the agency believes that the core 
business loan program missions, including the core job creation mission 
of the 504 Loan Program (15 U.S.C. 695) and the small business credit 
support mission of the 7(a) Loan Program (15 U.S.C. 636), would best be 
served by focusing on the statutory requirement regarding the 
availability of credit on reasonable terms without attempting to 
document and enforce precise determinations regarding the 
appropriateness of personal resource contributions. The agency is 
therefore proposing to

[[Page 12638]]

eliminate the personal resources test from the regulations for both 
loan programs.
    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. In 
addition, it is important to note that agency regulations require that 
persons with a 20% or more ownership interest in an applicant guarantee 
a business loan program financing (and other persons may also be 
required to provide personal guarantees). This means that if such 
guarantors have substantial personal resources, those resources will 
conditionally support the financing.
    SBA invites comments on this specific issue and on the general 
issue of whether a personal resources test should be retained and, if 
so, in what form.

C. The ``9-Month Rule'' (applies to 504 Loan Program Only)

    Under current 504 Loan Program regulations, Sec.  120.882(a) 
permits financing of expenses toward a project only if they were 
incurred ``within nine months prior to receipt by SBA of a complete 
loan application, unless the time limit is extended or waived by SBA 
for good cause.'' SBA proposes to eliminate this nine month limitation 
and permit financings of expenses toward a project regardless of when 
they were incurred. Some general context related to this proposed 
revision follows.
    Refinancing of debt unrelated to the 504 project is currently 
allowed in the 504 Loan Program only pursuant to statutorily limited 
circumstances as set forth in Sec.  120.882(e) and (g). There are, 
however, circumstances when an applicant might incur short term debt to 
cover expenses directly attributable to a larger project that is 
eligible for financing under the 504 Loan Program. This is particularly 
true when building construction is part of the project. Acquisition of 
a building, and particularly the decision to construct from the ground-
up, is the result of planning over months, if not years. Diligent small 
business owners approach the process in a series of steps based upon 
what is affordable and how the business is performing. Financing for 
these initial expenditures also is determined by what is cost-effective 
for the business. In such cases, the agency has under certain 
conditions allowed those expenses/debts to be included as part of a 504 
Loan Program project. What follows is a short summary of the relevant 
history of how those conditions evolved under the program to its 
current criteria.
    On July 5, 1985 (50 FR 27754), SBA proposed Sec.  108.503-5(d), 
which allowed financing of expenditures made in anticipation of a 
financing under the 504 Loan Program if, among other conditions, the 
applicant filed a written notice to SBA within 60 days after the 
expenditure.
    On June 6, 1986 (51 FR 20764), SBA finalized the above rule and, in 
response to comments, added that previously acquired land should be 
eligible to be included in project costs without regard to the timing 
of the acquisition. It was added as Sec.  108.503-5(d)(2) and the rule 
above became (d)(1).
    On January 31, 1996 (61 FR 3226), SBA published final regulations 
which essentially re-wrote the loan program regulations and in the 
process added what is now referred to as the ``9-month rule'' providing 
the following explanation in the preamble:

    ``Sec.  120.882. In the current regulations, costs incurred by a 
Borrower in anticipation of receiving a 504 loan are not eligible to 
be included in Project costs unless the applicant has filed a 
written notice with the CDC and SBA within 60 days of incurring the 
expense and SBA gives written approval. As a result, CDCs and SBA 
receive notices from many potential borrowers considering 504 
financing who desire to maximize potential financing. Many of these 
businesses never actually apply or their applications are denied. In 
those cases, the written notices are a useless paperwork burden on 
SBA, the CDC and the applicant. Therefore, SBA proposed in Sec.  
120.882(a)(2) to eliminate the requirement for written notice and 
allow as an eligible Project cost any expense incurred toward a 
Project within six months of receipt by SBA of a complete loan 
application.
    SBA received 16 comments opposing the 6 month limit. Commenters 
pointed out that in actual practice the time it takes to reach the 
point of application is often far greater than 6 months. In many 
metropolitan areas, the zoning use permits, building permits, and 
other clearances can take 9 to 12 months. Often engineering plans 
and architectural drawings may need to be completed or redone, and 
lengthy environmental studies may be required. In states like 
Minnesota with long winters, the delay between site preparations and 
construction may span more than 6 months.
    The intent of the proposed rule was to alleviate unnecessary 
paperwork. It was not intended to limit eligible costs. Therefore, 
SBA increases the limit in this final rule to 9 months and adopts a 
comment suggesting a waiver of the limit by the SBA District Office 
for good cause, which waiver should not be unreasonably withheld.'' 
(61 FR 3226 at 3233, (January 31, 1996)).

    In practice, exceptions to the 9-month rule have been granted 
regularly because, generally speaking, the date the expense was 
incurred is a poor indicator as to whether the expense was directly 
attributable to the applicant's 504 project. For example, because of 
the weak economy, many businesses' expansion plans have been delayed or 
placed on hold. Now, in the post-recession recovery period, many small 
business owners are preparing to resume their plans only to discover 
that expenditures already made, or the method of financing those 
expenditures, results in those costs not being eligible for 504 
financing. As a result, SBA receives about 6-8 rule exceptions requests 
on a weekly basis, for an approximate total of 312-416 such requests 
yearly. Out of those requests, SBA declines only 1-2 per week, for an 
approximate total of 52-100 denials yearly. Based on these estimates, 
in the last five years, SBA has declined about 19% of rule exception 
requests, while approving approximately 81% of such requests. This data 
confirms the agency's belief that determining whether an expense has 
been incurred by an applicant for a 504 project requires a fact 
specific analysis which appropriate agency personnel need to make 
regardless of when the expense was incurred. As it relates to loan 
processing, the agency will continue to review any expense that was 
incurred prior to the date of application to ensure that it is 
``directly attributable'' to the project. Based on SBA's experience in 
the application of the 9-month rule and having, for the most part, 
approved requests from applicants that SBA make an exception to this 
policy, the agency believes that the 9-month restriction can and should 
be eliminated from the regulations.

D. CDC Operational and Organizational Requirements

    SBA also proposes to revise regulations dealing with corporate 
governance including eliminating the requirement for CDC membership and 
emphasizing the responsibility of the board of directors. A detailed 
discussion of these proposed changes can be found in the section-by-
section analysis below.

E. Other Changes

    The proposed rule would make other technical corrections and 
changes resulting in simplification of some regulations for both the 
504 Loan Program and the 7(a) Loan Program, and a discussion of these 
proposed changes can be found in the section-by-section analysis.

[[Page 12639]]

II. Section-by-Section Analysis

    Section 120.102 Funds not available from alternative sources, 
including personal resources of principals. SBA proposes to remove this 
regulation regarding the availability of personal assets of the 
principals of the Borrower. For the reasons described above under 
Background Information, SBA has determined that in order to better 
serve the small business community and economic development, the 
regulation should be removed for both the 504 Loan Program and the 7(a) 
Loan Program.
    Section 120.816 CDC nonprofit status and good standing. SBA 
proposes to redesignate the current Sec.  120.820 as a new Sec.  
120.816. The content would remain unchanged.
    Section 120.818 Applicability to existing For-Profit CDCs. SBA 
proposes to add this new section to clarify that, unless expressly 
provided otherwise in the regulations, any Loan Program Requirement 
that applies to non-profit CDCs also applies to for-profit CDCs. This 
proposed change reflects current SBA practice.
    Section 120.820 CDC Affiliation. SBA proposes to substitute the 
current Sec.  120.820 with a new Sec.  120.820 that sets forth 
requirements regarding CDC affiliations. In paragraph (a), SBA proposes 
to require that a CDC be independent and not be affiliated with any 
Person (as defined in Sec.  120.10) except as permitted under this 
section. In paragraph (b), SBA proposes to permit CDCs to be affiliated 
with non-profit economic development entities or State and local 
government political subdivisions (e.g., councils of government). In 
paragraph (c), SBA proposes to permit a CDC to continue to be 
affiliated with a 7(a) Lender if: (1) the affiliation was in effect as 
of the effective date of this regulation; and (2) the 7(a) Lender is 
either a state development company approved by SBA as of November 6, 
2003, or a credit union. This proposed change will permit the 
continuation of existing relationships between CDCs and 7(a) Lenders 
that are credit unions or state development companies, but does not 
permit the creation of such relationships going forward. In paragraph 
(d), consistent with current policy, SBA proposes adding a provision 
prohibiting one CDC from affiliating with or investing in or financing, 
directly or indirectly, another CDC.
    Section 120.822 Membership. Currently, this section requires CDCs 
to have at least 25 members or stockholders, and also sets forth 
membership group requirements. SBA proposes to eliminate the 
requirement that a CDC have membership. Now that CDCs currently have 
authority to loan in a statewide (or multistate) area, the local 
membership board does not have the same impact as when CDCs represented 
a smaller service area. Maintaining both membership and a Board of 
Directors places an unnecessary burden on CDCs. Lessening this burden 
may encourage more entities to become CDCs, resulting in an expansion 
of the program and loans to small businesses. A CDC may continue to 
have membership but it is no longer an SBA requirement. Instead, SBA is 
emphasizing the responsibilities and duties of the CDC Board of 
Directors in the following section. Accordingly, SBA is proposing to 
remove Sec.  120.822 from the regulations.
    Section 120.823 CDC Board of Directors. In paragraph (a), SBA 
proposes to revise the regulations to emphasize the authority and the 
responsibilities of the CDC Board of Directors. The proposed regulation 
provides that the initial board may be created as permitted by state 
law. It also outlines proposed requirements for the directors' 
backgrounds and areas of expertise. SBA proposes adding a requirement 
that the Board size shall be not less than 11 voting directors and not 
more than 25. SBA recommends that CDCs have an odd number of Directors 
to avoid tie votes, which is consistent with best practices of Boards 
generally. SBA has based this revision upon an extensive review of the 
average size of non-profit boards, not limited to CDCs, which typically 
ranges from 7-15 Board members. Based upon the mission and 
responsibilities of CDCs and the average size for both for-profit and 
non-profit CDCs in the 504 Loan Program, however, SBA is proposing a 
range of 11-25 Board members. While SBA supports limiting the number of 
directors on the Board for efficiency of operations, the agency also 
understands that an important function of the Board is to provide 
representation for the communities served by the CDC. Having an upper 
limit of 25 directors for the CDC Board would provide CDCs with the 
opportunity to convert existing membership (currently set at a minimum 
of 25) to directors if they choose to do so. To increase community 
representation, the CDC would still have the option to have a 
membership to which the CDC may admit as many members as it deems 
appropriate.
    The Agency lists several proposed areas of expertise that it 
believes are essential to the successful operation of the CDC Board. 
SBA proposes to require that a CDC have, at a minimum, one director 
that is a representative from the economic, community or workforce 
development field and two directors that are representatives from the 
commercial lending field. This proposed change is intended to expand 
the pool of potential directors and to encourage more diversity and 
expertise on the Board. Retired individuals may represent the fields 
from which they retired, as the Agency recognizes the value of their 
knowledge and experience.
    Paragraph (b) regarding commercial lending experience is language 
from the existing regulation except that SBA proposes to increase the 
minimum number of voting directors on the Board with commercial lending 
experience from one to two. Further, at least two directors with 
commercial lending experience must be present and vote when the Board 
is acting on SBA approvals or servicing actions. SBA believes that this 
requirement is prudent now that the maximum loan amount has been 
increased to $5,000,000 and, in some cases, $5,500,000.
    Paragraph (c) outlines the proposed minimum requirements for Board 
meetings and explicitly establishes the Board's responsibilities for 
the actions of the CDC, its staff, and any committees established by 
the Board of Directors. The requirement in subparagraph (c)(1) does not 
reflect any changes to the current regulations. To ensure effective 
operation and oversight of the CDC by the Board, and to encourage 
maximum involvement by each Director, the Agency proposes requiring 
that a quorum of not less than 50% of the Board be present to conduct 
all business. Non-voting directors will not be included for the 
purposes of establishing a quorum. SBA is aware that some CDCs were 
requiring that a quorum be present only to begin a meeting; this 
practice would not comply with the proposed rule. In subparagraph 
(c)(3), SBA proposes that meetings may be held in any manner permitted 
by state law, recognizing that there are methods for meeting other than 
being physically present. Paragraph (c)(4) proposes to maximize 
diversity on the Board by limiting representation by commercial lenders 
to less than 50% of the Board of Directors. Paragraph (c)(5) proposes 
to limit the ability of an outside entity (including affiliates of that 
entity) to control the Board by restricting the entity's representation 
on the CDC Board to one member.
    In paragraph (d), SBA proposes to require that the Board be 
responsible for ensuring that the structure and operation of the CDC, 
as set forth in the Bylaws, comply with SBA's Loan Program 
Requirements. In

[[Page 12640]]

subparagraphs (d)(1) and (2), SBA proposes to require that the Board be 
responsible for setting the mission and hiring, firing, supervising and 
evaluating the CDC manager. To emphasize the fiscal responsibility of 
the Board as it relates to salaries, subparagraph (d)(3) explicitly 
outlines the duties of the Board to set salaries for the CDC manager 
and to review all other salaries to provide greater transparency and 
accountability. SBA requires that a Report on Compensation be included 
in the Annual Report (see proposed Sec.  120.830). SBA also proposes in 
subparagraph (d)(4) to provide the CDC with flexibility in determining 
whether to have committees, but addresses the requirements for 
Executive and Loan Committees, if established. Emphasis has been placed 
on the Board of Directors in this proposed rule. If a Board chooses to 
have an Executive Committee, then its members must be chosen from the 
Board as the Agency does not want this authority to be delegated to 
individuals who are not members of the Board. The Executive Committee 
must be chosen by and from the Board and meet the same requirements as 
the Board with the exception that the Executive Committee would be 
required to have no fewer than 5 voting members, and there must be a 
quorum of at least 5 voting members to conduct business. The proposed 
regulations also permit the Board to establish a Loan Committee and 
outline the requirements as to committee membership selection and 
background. As is provided in the current rule regarding the Loan 
Committee, no CDC staff may serve on the Loan Committee. Further, the 
regulation as proposed defines a quorum as five voting Loan Committee 
members. Subparagraph (d)(4)(ii)(D) additionally proposes that there be 
no actual or appearance of a conflict of interest. For example, a 
member of the Loan Committee must not participate in deliberations on a 
loan for which the Third Party Lender is the Committee member's 
employer.
    Subparagraph (d)(5), as proposed, requires the Board to ensure that 
the CDC's expenses are reasonable and customary, and proposed 
subparagraph (d)(6) requires the Board to hire an independent auditor 
to ensure compliance with Loan Program Requirements.
    The proposed provisions in subparagraphs (d)(7) and (8) emphasize 
the requirement that the Board monitor the portfolio and review the 
semiannual status report from the CDC to ensure that the Board provides 
appropriate oversight of the CDC's portfolio. SBA proposes to add 
requirements in subparagraph (d)(9) that the Board ensure that the CDC 
establishes and maintains adequate reserves to enable the CDC to 
operate.
    As provided in current Sec.  120.825, a CDC must invest in its Area 
of Operations. Subparagraph (d)(10) of Sec.  120.823 proposes to 
require that the Board approve all investments of over $2,500 and that 
the CDC manager approve investments of $2,500 or less in order to 
ensure that the investments constitute appropriate economic development 
activity and that such investments do not compromise the adequacy of 
the reserves. Examples of economic development activities could include 
non-profit activities such as workforce development programs, lending 
programs or other like activities in the CDC's Area of Operations.
    The Agency proposes to require in subparagraph (d)(11) that the 
Board establish a policy in the Bylaws of the CDC prohibiting an actual 
or apparent conflict of interest, and enforce such policy. The agency 
would expect that the policy would provide, among other things, that no 
director may participate in deliberations on a loan if the director is 
employed by or is otherwise associated with the Third Party Lender. 
Subparagraphs (d)(12) and (d)(13), as proposed, express the Board's 
retention of accountability for all actions of the CDC, and establishes 
the responsibility for establishing written internal control polices as 
set forth in Sec.  120.826. SBA proposes to add subparagraph (d)(14) 
requiring the CDC's Board of Directors to establish commercially 
reasonable loan approval policies, procedures, and standards. The CDC's 
credit approval process and delegations of authority, if any, must be 
set forth in the Bylaws. In addition, the loan must be credit-approved 
before the application is submitted to SBA. The proposed rule would 
require that the Board of Directors, or the Executive Committee, if 
authorized by the Board, provide credit approval for loans greater than 
$2,000,000 prior to submission to the agency, as SBA believes that it 
is important that the Board, or Executive Committee, approve these 
larger loans. However, SBA recognizes that Boards may not meet 
frequently enough to provide the needed credit approval in a timely 
manner prior to submission of an application to SBA and that allowing 
approval of smaller loans by the Loan Committee would present minimal 
additional risk to the Agency. Therefore, SBA is proposing to allow 
Boards to delegate authority to the Loan Committee to provide credit 
approval of: (1) loans of less than $1 million, and (2) loans of $1 
million to $2 million subject to ratification by the Board or the 
Executive Committee prior to debenture closing. SBA invites comment on 
this proposal. To further emphasize the responsibilities of the Board, 
in subparagraph (d)(15), SBA proposes an annual certification by all 
Board members acknowledging their responsibilities.
    In paragraph (e), SBA proposes to add the requirement that the 
Board must maintain directors' and officers' liability and errors and 
omissions insurance to protect the CDC. The Agency requires at least 
$5,500,000 for each occurrence and $5,500,000 in the aggregate per 
year, as well as a deductible of not more than $50,000 for both 
directors' and officers' liability insurance and errors and omissions 
insurance. These coverage amounts correspond to the maximum loan 
amount. SBA invites comment on the amounts of both the insurance and 
the deductible.
    Section 120.830 Reports a CDC must submit. SBA proposes to revise 
the requirements for reporting by CDCs in order to improve transparency 
and accountability and for other purposes discussed in this paragraph. 
In paragraph (a), SBA proposes adding a requirement that copies of 
Federal tax returns be submitted in the Annual Report to assist the 
Agency in reducing risk by reviewing the financial condition of the CDC 
and compensation of CDC employees. The requirements for the audited or 
reviewed financial statements are set forth in subparagraph (a)(1) and 
remain unchanged. In addition, as a matter of practice, SBA does not 
require a CDC to submit an Annual Report for the year in which it was 
certified if the CDC is certified by SBA within 6 months of its fiscal 
year-end, and SBA proposes to reflect this practice in the regulations. 
In subparagraph (a)(2), SBA proposes to add a requirement for an annual 
compensation report covering all current and former officers and 
directors receiving compensation during the covered period, and any 
current and former employees and independent contractors with total 
compensation of more than $100,000 during the covered period. For this 
purpose, total compensation includes all compensation, including 
salary, bonuses and expenses. Additionally, in subparagraph (a)(3), the 
Agency proposes to require that the annual report include an annual 
certification by each of the directors that he or she has read and 
understands the requirements set forth in the proposed Sec.  120.823. 
In subparagraph (a)(4), SBA is proposing to require that the CDC report 
on investments in economic development

[[Page 12641]]

activities in each State in which the CDC has an outstanding 504 loan. 
With the exception of the revisions noted above, the reporting 
requirements for CDCs remain the same.
    Section 120.835 Application to expand an Area of Operations. SBA 
proposes to incorporate subparagraph (c)(1) into paragraph (c) and 
remove subparagraph (c)(2), which currently requires the CDC to meet 
the requirements as to membership for each state in a Multi-state 
expansion, since the proposed revisions to Sec.  120.822 make 
membership optional.
    Section 120.882 Eligible Project costs for 504 loans. SBA proposes 
to eliminate paragraph (a)(2) of Sec.  120.882, which limits Project 
expenses eligible for 504 Loan Program financing to those incurred 
within 9 months prior to receipt by SBA of a complete loan application. 
(The cost of acquiring land to be used in the Project is not subject to 
the 9-month restriction.)
    For the reasons described above under Background Information, SBA's 
proposal would permit prior expenses that are directly attributable to 
the 504 project to be considered eligible project costs regardless of 
when those expenditures were made. If financing was required for the 
costs incurred, SBA would determine whether the 504 loan should be made 
under Sec.  120.882(e) as a 504 project that includes a refinancing 
component or under Sec.  120.882(a) because the costs are directly 
attributable to the project.
    Section 120.920 Required participation by the Third Party Lender. 
SBA proposes revising this section to provide that if a Third Party 
Lender requires collateral in addition to that which the CDC takes, the 
Third Party Lender, in the event of liquidation, must first apply the 
proceeds from the sale of the additional collateral to the balance of 
the Third Party Lender's loan. This marshaling of assets would protect 
the CDC's position in the Common Collateral (as defined in the proposed 
revision to this section) and could lead to greater recovery for SBA
    Section 120.925 504 Preferences. SBA proposes removing this 
section, and addressing the concern with respect to the application of 
the proceeds from additional collateral held by the Third Party Lender 
in Sec.  120.920 as described above.
    Section 121.103 How does SBA determine affiliation? SBA proposes to 
amend this section to provide that affiliation for 7(a), 504 and 
microloan loan applicants would be determined under a new Sec.  
121.302, as described below, and not under Sec.  121.103.
    Section 121.302 What are the standards for determining affiliation 
for loan applicants?
    SBA proposes to redefine ``affiliation'' for the purpose of the 
business loan programs. Proposed paragraph (a) of Sec.  121.302 
contains a statement of general principles of affiliation for business 
loan applicants and incorporates the exceptions to affiliation set 
forth in Sec.  121.103(b). Proposed paragraph (b) sets forth the 
affiliation principles based on ownership. Proposed paragraph (c) 
describes the effect on affiliation of stock options, convertible 
securities, and agreements to merge. Proposed paragraph (d) outlines 
affiliation based upon common management. Proposed paragraph (e) 
incorporates Sec.  121.103(i) regarding affiliation based on franchise 
and license agreements. Proposed paragraph (f) requires that each 
applicant for a 7(a) loan or a 504 loan submit with its application an 
Affidavit in which discloses all owners of the applicant and the 
percentage of ownership of each, and any affiliates as determined under 
this section.
    The existing Sec. Sec.  120.302 through 120.305 are proposed to be 
redesignated as Sec. Sec.  120.303 through 120.306, respectively, 
without any further changes.

Compliance With Executive Orders 13563, 12866, 12988, and 13132, the 
Paperwork Reduction Act (44 U.S.C., Ch. 35,), and the Regulatory 
Flexibility Act (5 U.S.C. 601-612)

Executive Order 13563 and Executive Order 12866

    The Office of Management and Budget (OMB) has determined that this 
proposed rule is a ``significant'' regulatory action for the purposes 
of Executive Order 12866. Accordingly, the next section contains SBA's 
Regulatory Impact Analysis. However, this is not a major rule under the 
Congressional Review Act, 5 U.S.C. 800.
Regulatory Impact Analysis
    1. Is there a need for this regulatory action?
    The agency believes it needs to reduce regulatory burdens and 
expand business loan program access to reinvigorate the programs and 
facilitate job creation.
    2. What are the potential benefits and costs of this regulatory 
action?
    As stated above, the potential benefits of this proposed rule are 
based on its elimination of unnecessary participation burdens and 
eligibility criteria. Specifically, the proposed rule would eliminate 
certain eligibility criteria related to the personal resources of 
certain people or companies associated with the applicant. It would 
also exempt the business loan program from certain rules that determine 
whether an entity is deemed affiliated with an applicant. When an 
entity is determined to be affiliated with an applicant, then that 
entity's receipts and employees are added to those of the applicant 
when determining its size. Thus, certain businesses are deemed to be 
ineligible for assistance because they are not deemed to be ``small'' 
for program purposes by virtue of their combined size with affiliated 
entities. By eliminating unnecessary affiliation tests from the 
business loan programs, independently owned and controlled small 
businesses that would otherwise be ineligible for business loan program 
assistance will become eligible. In addition, the excessive burden 
related to providing documentation for size evaluation for numerous 
affiliates now faced by lenders and borrowers would be significantly 
reduced by the proposed rule.
    In the 504 Loan Program, SBA is proposing to eliminate what is 
commonly referred to as the ``9-month rule''. The 9-month rule 
essentially states that costs incurred by an applicant that otherwise 
would be eligible for financing under the 504 Loan Program are 
presumptively deemed to be ineligible project costs if incurred more 
than 9 months prior to a complete loan application submitted by an 
applicant. Also pertaining only to the 504 Loan Program, the proposed 
rule would revise regulations dealing with corporate governance 
including eliminating the requirement for CDC membership and 
emphasizing the responsibility of the board of directors. CDCs 
participating in the 504 Loan Program would no longer need to maintain 
a membership, thus eliminating that program participation burden. 
Requirements for the CDC Board of Directors are clarified and detailed 
to compensate for the potential loss of oversight that might result 
from the lack of CDC membership participation. SBA could have allowed 
CDC Directors to operate without clearly articulated basic standards 
that are commonly accepted best practices that most CDCs already 
follow. SBA welcomes comments and suggestions on the benefit of 
allowing CDC Boards to operate without the basic governance standards 
and oversight proposed in this rule.
    With respect to CDC Board requirements, the agency proposes to 
establish a minimum quorum of 50% of the Board and to require that the 
Board set the CDC manager's salary and review

[[Page 12642]]

all CDC staff salaries. There are additional operational requirements 
which are discussed more fully in the section-by-section analysis of 
this proposed rule. It is the agency's view that these rules basically 
would codify best practices for CDC Board operation and would not 
significantly add to the burden of being a responsible CDC director. 
The agency encourages public comment on the Board requirements, 
especially with respect to any possible significant economic impact, as 
well as suggestions regarding how to ensure proper Board operations in 
a less burdensome way.
    Finally, there are miscellaneous proposed revisions which clarify 
or slightly revise exiting regulations with very minor regulatory 
impact. For example, consistent with current policy, Sec.  120.818 
clarifies that CDC requirements apply to for-profit CDCs. Another 
example is Sec.  120.830, which the agency believes would allow several 
CDCs to maintain existing affiliations and still qualify for expanded 
CDC status without impacting the operational requirements of other 
CDCs. With respect to any of the proposed revisions relating to CDC 
operational and organizational requirements, the agency welcomes any 
comments regarding potentially significant impact on CDC operations and 
views regarding how the agency can responsibly reduce CDC operational 
and organizational compliance burdens.
    3. What alternatives have been considered?
    One ``alternative'' would be to eliminate even more regulatory 
burdens and the agency enthusiastically encourages public comment and 
suggestions on how that can be done responsibly without substantially 
increasing the risk of waste, fraud, or abuse of the programs or 
otherwise threatening the integrity of the business loan program or 
taxpayer dollars. With respect to the proposed changes to CDC Board of 
Director requirements, the agency considered allowing CDC directors to 
operate with virtually no agency oversight or standards, relying on 
state non-profit corporation laws and state oversight to ensure proper 
Board performance. This idea was quickly rejected because SBA's review 
of actual state oversight of non-profit directors and the applicable 
state law requirements indicated that state oversight and laws would 
not provide the parameters and oversight necessary for a Federal loan 
program that potentially puts billions of taxpayer dollars at risk each 
year.

Executive Order 13563

    A description of the need for this regulatory action and benefits 
and costs associated with this action, including possible 
distributional impacts that relate to Executive Order 13563, are 
included above in the Regulatory Impact Analysis under Executive Order 
12866.
    The business loan programs operate through the agency's lending 
partners, which are 7(a) Lenders and CDCs. The agency has held public 
forums and meetings which allowed it to reach hundreds of its lending 
partners and gain valuable insight, guidance, and suggestions from many 
of them and the trade associations which represent many of them. The 
agency's outreach efforts to engage stakeholders before proposing this 
rule was extensive.

Executive Order 12988

    This action meets applicable standards set forth in Sections 3(a) 
and 3(b) (2) of Executive Order 12988, Civil Justice Reform, to 
minimize litigation, eliminates ambiguity, and reduce burden. The 
action does not have retroactive or preemptive effect.

Executive Order 13132

    SBA has determined that this proposed rule will not have 
substantial, direct effects on the States, on the relationship between 
the national government and the States, or on the distribution of power 
and responsibilities among the various levels of government. Therefore, 
for the purposes of Executive Order 13132, SBA has determined that this 
proposed rule has no federalism implications warranting preparation of 
a federalism assessment.

Paperwork Reduction Act, 44 U.S.C., Ch. 35

    The SBA has determined that this proposed rule would impose 
additional reporting and recordkeeping requirements under the Paperwork 
Reduction Act (PRA), 44 U.S.C. Chapter 35. First, SBA proposes to amend 
the currently approved CDC Annual Report to require CDCs to report on 
executive compensation and economic development projects, and to submit 
a copy of the CDC's tax return. Under the proposed rule, each CDC 
director must certify that he or she has read and understands the 
requirements set forth in 13 CFR 120.823.
    Second, SBA proposes to require each loan applicant to certify in 
an Affidavit (the ``Applicant Affidavit on Affiliation'') as to the 
applicant's affiliation with any other entities. Requiring submission 
of this Affidavit would significantly reduce the burden on the small 
businesses and the CDCs as the small businesses applying for a 504 or 
7(a) loan would be required to submit certain documentary evidence 
(e.g., credit reports, financial statements and tax returns) only with 
respect to their affiliates as defined in the proposed rule. In 
addition, applicants would be required to identify all owners of the 
applicant as opposed to each owner of 20% or more interest as is now 
required only on Form 4, Application for Business Loan.
    As a result of these new requirements, SBA proposes to revise the 
information collections identified below:
    1. Title and Description of Information Collection: The Certified 
Development Company (CDC) Annual Report (SBA Form 1253) is the method 
through which the CDC provides information to SBA on economic 
development, its financial condition, operations and employment impact. 
The additional information that would be required to be submitted with 
the Annual Report is a certification by each CDC director, a report on 
compensation, and a copy of the CDC's federal tax return. This 
information collection will also be revised to reflect changes in 
governance of CDC membership; composition of CDC board of directors and 
increases to insurance coverage.
    OMB Control Number: 3245-0074.
    Description of and Estimated Number of Respondents: All CDCs must 
provide an annual report. Currently there are approximately 260 CDCs. 
There is 1 form per respondent. SBA has prepared an estimate based on 
the fact that respondents keep the information requested in the 
ordinary course of business (all the loan information including jobs 
created and retained.).
    Estimated Number of Responses: 260 (260 CDCs x 1 form per 
respondent = 260).
    Estimated Time per Response: SBA estimates the time needed to 
complete this collection will average 28 hours.
    Total Estimated Hour Burden: 260 x 28 hours = 7,280 total annual 
burden hours. This is 168 hours less than the current OMB inventory 
(7,488).
    2. Title and Description of Information Collection: Applicant 
Affidavit on Affiliation as to applicant's affiliation with any other 
entities. This new information collection, as described above, will be 
submitted with the following applications:
    (i) Application for Section 504 Loan (SBA Form 1244).
    OMB Control Number: 3245-0071
    Description of and Estimated Number of Respondents: The Applicant 
would execute this Affidavit which would be part of exhibit 12 to SBA 
Form 1244.

[[Page 12643]]

Based upon FY 2011 loan totals, SBA estimates that 6,800 respondents 
will complete the Affidavit annually (4,625 ASM submission + 2,75 
standard submissions = 6,800).
    Estimated Number of Responses: 6,800 based upon the FY 2011 loan 
totals.
    Estimated Time per Response: SBA estimates that each applicant 
would require 15 minutes to complete the new proposed form, thereby 
decreasing the total estimated burden for this collection, which 
depending on the Lenders status, is currently 2.25 hours or 2.45 hours 
per application.
    Total Estimated Burden: 15,736 hours, which is identical to current 
OMB inventory.
    (ii) Application for Business Loan (SBA Form 4-I and 4 Schedule A).
    OMB Control Number: 3245-0016.
    Description of and Estimated Number of Respondents: 17,300 
Applicants for 7(a) loans based upon FY 2011 totals.
    Estimated Number of Responses: 32,130 based upon the FY 2011 
totals.
    Estimated Time per Response: SBA estimates that each applicant 
would require 15 minutes to complete the new proposed form, which would 
result in a corresponding reduction in the current burden for this 
collection.
    Total Estimated Burden: 206,340 hours (8.625 hours less than 
current OMB inventory).
    (iii) SBA Express, Export, Express, Small Loan Advantage, PLP-
CapLines, and Pilot Loan Programs (Patriot Express and Dealer Floor 
Plan) Borrower Information Form (SBA Form 1919, 1920SX (A, B & C) and 
2237).
    OMB Control Number: 3245-0348.
    Description of and Estimated Number of Respondents: 4,450 
Applicants for SBA Express, Export Express, Small Loan Advantage, PLP-
Caplines and Pilot Loan Programs based upon FY 2011 totals.
    Estimated Number of Responses: 117.900.
    Estimated Time per Response: 12 minutes.
    Total Estimated Burden: 22,620 hours (36,236 hours less than 
current OMB inventory).
    (iv) Lender Advantage (SBA Form 2301-A, B & C).
    OMB Control Number: 3245-0361.
    Description of and Estimated Number of Respondents: 15,900 
Applicants for SBA's Lender Advantage Loan Initiative Program based 
upon a projection of program activity during FY 2013.
    Estimated Number of Responses: 15,900 respondents based upon a 
projection of program activity during FY 2013.
    Estimated Time per Response: SBA estimates that each applicant 
would require 30 minutes to complete the new proposed form, which would 
result in a reduction in the current burden hours for this collection.
    Total Estimated Burden: 46,095 hours (2,895 hours less than current 
OMB inventory).
    (v) PCLP Quarterly Loan Reserve Report and PCLP Guarantee Request 
(SBA Forms 2233 and 2234-A, B & C).
    OMB Control Number: 3245-0346.
    Description of and Estimated Number of Respondents: 19 PCLP 
Lenders.
    Estimated Number of Responses: 1,700 respondents based on an 
estimate of the loan volume.
    Estimated Time per Response: SBA estimates that each applicant 
would require 50 minutes to complete the new proposed form, which would 
result in a reduction in the current burden hours for this collection.
    Total Estimated Burden: 1,402 hours less than current OMB 
inventory.
    SBA has submitted these amended collections to the Office of 
Management and Budget (OMB) for review, and invites the public to 
comment on the proposed changes, particularly on: (1) Whether the 
proposed collection of information is necessary for the proper 
performance of the program, including whether the information will have 
a practical utility; (2) the accuracy of SBA's estimate of the burden 
of the proposed collections of information; (3) ways to enhance the 
quality, utility, and clarity of the information to be collected; and 
(4) ways to minimize the burden of the collection of information on 
respondents, including through the use of automated collection 
techniques, when appropriate, and other forms of information 
technology. Please send comments by the closing date for comment for 
this interim final rule to SBA Desk Officer, Office of Management and 
Budget, Office of Information and Regulatory Affairs, 725 17th Street 
NW., Washington, DC 20503, and to Linda Reilly, Chief, 504 Program 
Branch, Office of Financial Assistance, Small Business Administration, 
409 Third Street SW., Washington, DC 20416.

Regulatory Flexibility Act, 5 U.S.C. 601-612

    When an agency issues a rulemaking proposal, the Regulatory 
Flexibility Act (RFA), 5 U.S.C. 601-612, requires the agency to 
``prepare and make available for public comment an initial regulatory 
analysis'' which will ``describe the impact of the proposed rule on 
small entities.'' Section 605 of the RFA allows an agency to certify a 
rule, in lieu of preparing an analysis, if the proposed rulemaking is 
not expected to have a significant economic impact on a substantial 
number of small entities. Although the rulemaking will impact all of 
the approximately 4,500 7(a) Lenders (some of which are small) and all 
of the approximately 260 CDCs (all of which are small), SBA does not 
believe the impact will be significant. As stated above, the proposed 
rule will expand access to the business loan program but this will not 
increase the burden of the agency's lending partners because they 
choose their own level of program participation (i.e., 7(a) Lenders and 
CDCs are not required to process more loan applications simply because 
more small businesses are eligible to apply for a business loan). For 
those CDCs and lenders that process more businesses loans, the benefit 
of the increase in revenue will far exceed any increased burden. In 
addition, the proposed elimination of certain program participation 
requirements would not have a substantial economic impact or cost on 
the small business borrower, lender or CDC.
    SBA believes that this rule is SBA's best available means for 
facilitating American job preservation and creation by removing 
unnecessary regulatory requirements. Since the main purpose of this 
proposed rule is to reduce unnecessary regulatory burdens and program 
eligibility criteria, a review of the preamble sections above will 
provide more detailed explanations regarding how and why this proposed 
rule will reduce regulatory burdens and responsibly increase program 
participation flexibility. For these reasons, SBA has determined that 
there is no significant impact on a substantial number of small 
entities. SBA invites comment from members of the public who believe 
there will be a significant impact either on CDCs, or their borrowers.

List of Subjects

13 CFR Part 120

    Community development, Equal employment opportunity, Loan 
programs--business, Reporting and recordkeeping requirements, Small 
business.

13 CFR Part 121

    Grant programs-business, Individuals with disabilities, Loan-
programs-business, Reporting and recordkeeping requirements, Small 
businesses.

    For the reasons stated in the preamble, SBA proposes to amend 13 
CFR parts 120 and 121 as follows:

PART 120--BUSINESS LOANS

0
1. The authority for 13 CFR part 120 continues to read as follows:


[[Page 12644]]


    Authority:  15 U.S.C. 634(b)(6), (b)(7), (b)(14), (h) and note, 
636(a), (h) and (m), 650, 687(f), 696(3) and 697(a) and (e); Pub. L. 
111-240, 124 Stat. 2504.


Sec.  120.102  [Removed]

0
2. Remove Sec.  120.102.


Sec.  120.820  [Redesignated as Sec.  120.816]

0
3. Redesignate Sec.  120.820 as Sec.  120.816.
0
4. Add Sec.  120.818 to read as follows:


Sec.  120.818  Applicability to existing for-profit CDCs.

    Unless expressly provided otherwise in the regulations, any Loan 
Program Requirement that applies to non-profit CDCs also applies to 
for-profit CDCs.
0
5. Revise newly redesignated Sec.  120.820 to read as follows:


Sec.  120.820  CDC Affiliation.

    (a) A CDC must be independent and may not be affiliated (as 
determined in accordance with Sec.  121.103) with any Person (as 
defined in Sec.  120.10) except as permitted under this section.
    (b) A CDC may be affiliated with an entity whose function is 
economic development in the same Area of Operations and that is either 
a non-profit entity or a State or local government or political 
subdivision (e.g., council of governments).
    (c) A CDC that is affiliated with a 7(a) Lender may continue such 
affiliation if:
    (1) The affiliation was in effect as of [EFFECTIVE DATE OF FINAL 
RULE], and
    (2) The 7(a) Lender is either a state development company approved 
by SBA as of November 6, 2003, or a credit union.
    (d) A CDC must not be affiliated with, or directly or indirectly 
invest in or finance, another CDC.


Sec.  120.822  [Removed]

0
6. Remove Sec.  120.822.
0
7. Revise Sec.  120.823 to read as follows:


Sec.  120.823  CDC Board of Directors.

    (a) The CDC, whether for-profit or nonprofit, must have a Board of 
Directors with at least eleven (11), and no more than twenty-five (25), 
voting directors. The Board must be actively involved in encouraging 
economic development in the Area of Operations. The initial Board may 
be created by any method permitted by applicable State law. At a 
minimum, the Board must have directors with background and expertise in 
internal controls, financial risk management, commercial lending, legal 
issues relating to commercial lending, and corporate governance. 
Directors may be either currently employed or retired. A CDC must have 
at least one voting director that represents the economic, community or 
workforce development fields, and at least two voting directors that 
represent the commercial lending field.
    (b) At least two voting members of the Board of Directors, other 
than the CDC manager, must possess commercial lending experience 
satisfactory to SBA. When the Board votes on SBA loan approval or 
servicing actions, at least two voting Board members, with such 
commercial lending experience, other than the CDC manager, must be 
present and vote.
    (c) The Board of Directors must meet at least quarterly and shall 
be responsible for the actions of the CDC and any committees 
established by the Board of Directors. In addition, the Board of 
Directors is subject to the following requirements:
    (1) Except for the CDC manager, no person on the CDC's staff may be 
a voting director of the Board;
    (2) A quorum must be present to transact business. The quorum shall 
be set by the CDC but shall be no less than 50% of the voting members 
of the Board of Directors;
    (3) Attendance at meetings may be through any format permitted by 
State law;
    (4) Directors from the commercial lending fields must comprise less 
than 50% of the representation on the Board; and
    (5) A CDC shall not permit more than one individual who is employed 
by or serves on the Board of Directors of a single entity (including 
the entity's affiliates) to serve on the CDC's Board of Directors.
    (d) The Board shall have and exercise all corporate powers and 
authority and be responsible for all corporate actions and business. 
There must be no actual or appearance of a conflict of interest with 
respect to any actions of the Board. The Board is responsible for 
ensuring that the structure and operation of the CDC, as set forth in 
the Bylaws, comply with SBA's Loan Program Requirements. The 
responsibilities of the Board include, but are not limited, to the 
following:
    (1) Approving the mission and the policies for the CDC;
    (2) Hiring, firing, supervising and annually evaluating the CDC 
manager;
    (3) Setting the salary for the CDC manager and reviewing all 
salaries;
    (4) Establishing committees, at its discretion, including the 
following:
    (i) Executive Committee. To the extent authorized in the bylaws, 
the Board of Directors may establish an Executive Committee. The 
Executive Committee may exercise the authority of the Board; however, 
the delegation of its authority does not relieve the Board of its 
responsibility imposed by law or Loan Program Requirements. No further 
delegation or redelegation of this authority is permitted. If the Board 
establishes an Executive Committee and delegates any of its authority 
to the Executive Committee as set forth in the bylaws of the CDC, the 
Executive Committee must:
    (A) Be chosen by and from the Board of Directors from the Board; 
and
    (B) Meet the same organizational and representational requirements 
as the Board of Directors, except that the Executive Committee must 
have a minimum of five voting members who must be present to conduct 
business.
    (ii) Loan Committee. The Board of Directors may establish a Loan 
Committee. The Loan Committee may exercise the authority of the Board 
only as set forth in paragraphs (d)(4)(ii)(A) through (D) of this 
section; however, the delegation of its authority does not relieve the 
Board of its responsibility imposed by law or Loan Program 
Requirements. If the Board of Directors chooses to establish a Loan 
Committee, no CDC staff or manager may serve on the Loan Committee. The 
Loan Committee must:
    (A) Be chosen by the Board of Directors from the membership (if 
any), shareholders or the Board;
    (B) Have a quorum of at least five (5) committee members authorized 
to vote;
    (C) Have at least two members with commercial lending experience 
satisfactory to SBA; and
    (D) Have no actual or appearance of a conflict of interest, 
including for example, a Loan Committee member participating in 
deliberations on a loan for which the Third Party Lender is the 
member's employer or the member is otherwise associated with the Third 
Party Lender.
    (5) Ensuring that the CDC's expenses are reasonable and customary;
    (6) Hiring directly an independent auditor to provide the financial 
statements in accordance with Loan Program Requirements;
    (7) Monitoring the CDC's portfolio performance on a regular basis;
    (8) Reviewing a semiannual report on portfolio performance from the 
CDC manager, which would include, but not be limited to, asset quality 
and industry concentration;
    (9) Ensuring that the CDC establishes and maintains adequate 
reserves for operations;
    (10) Ensuring that the CDC invests in economic development in each 
of the States in its Area of Operations in which it has a portfolio; 
and:

[[Page 12645]]

    (i) For investments of $2,500 or less: The CDC manager may approve 
such investments; and
    (ii) For investments over $2,500: The Board must approve each such 
investment.
    (11) Establishing a policy in the Bylaws of the CDC prohibiting an 
actual conflict of interest or the appearance of same, and enforcing 
such policy;
    (12) Retaining accountability for all of the actions of the CDC;
    (13) Establishing written internal control polices, in accordance 
with Sec.  120.826;
    (14) Establishing commercially reasonable loan approval policies, 
procedures, and standards. The Bylaws must include a credit approval 
process and set forth any delegations of authority to the Loan 
Committee and Executive Committee, if either Committee has been 
established. All 504 loan applications must have credit approval prior 
to submission to the Agency. The Loan Committee, if established, may be 
delegated the authority to provide credit approval for loans up to 
$2,000,000 but, for loans of $1,000,000 to $2,000,000, the Loan 
Committee's action must be ratified by the Board or Executive Committee 
prior to Debenture closing. Only the Board or Executive Committee, if 
authorized by the Board, may provide credit approval for loans greater 
than $2,000,000.
    (15) All members of the Board of Directors must annually certify in 
writing that they have read and understood this section, and copies of 
the certification must be included in the Annual Report to SBA.
    (e) The Board of Directors shall maintain Directors' and Officers' 
Liability and Errors and Omissions insurance in an amount of at least 
$5,500,000 per occurrence and in the aggregate per year with a 
deductible of not more than $50,000.
0
8. Amend Sec.  120.830 by revising paragraph (a) to read as follows:


Sec.  120.830  Reports a CDC must submit.

* * * * *
    (a) An Annual Report within one hundred-eighty days after the end 
of the CDC's fiscal year (to include Federal tax returns for that 
year). A CDC that is certified by SBA within 6 months of the CDC's 
fiscal year-end is not required to submit an Annual Report for that 
year. The Annual Report must include, but is not limited to, the 
following:
    (1) Audited or Reviewed Financial Statements as required in Sec.  
120.826(c) and (d) for the CDC and any affiliates or subsidiaries of 
the CDC.
    (i) Audited financial statements must, at a minimum, include the 
following:
    (A) Audited balance sheet;
    (B) Audited statement of income (or receipts) and expenses;
    (C) Audited statement of source and application of funds;
    (D) Such footnotes as are necessary to understand the financial 
statements;
    (E) Auditor's letter to management on internal control weaknesses; 
and
    (F) The auditor's report.
    (ii) Reviewed financial statements must, at a minimum, include the 
following:
    (A) Balance sheet;
    (B) Statement of income (or receipts) and expenses;
    (C) Statement of source and application of funds;
    (D) Such footnotes as are necessary to an understanding of the 
financial statements; and
    (E) The accountant's review report.
    (2) Report on compensation. CDCs are required to provide detailed 
information on total compensation (including salary, bonuses and 
expenses) paid within the CDC's most recent tax year for current and 
former officers and directors, and for current and former employees and 
independent contractors with total compensation of more than $100,000 
during that period.
    (3) Certification of members of the Board of Directors. Written 
annual certification by each Board member that he or she has read and 
understands the requirements set forth in Sec.  120.823.
    (4) Report on investment in economic development. Written report on 
investments in economic development in each State in which the CDC has 
an outstanding 504 loan.
* * * * *
0
8. Amend Sec.  120.835 by revising paragraph (c) to read as follows:


Sec.  120.835  Application to expand an Area of Operations.

* * * * *
    (c) Multi-State CDC Expansion. A CDC may apply to be a Multi-State 
CDC only if the state the CDC seeks to expand into is contiguous to the 
State of the CDC's incorporation and the CDC has a loan committee 
meeting the requirement of Sec.  120.823.
0
9. Amend Sec.  120.882 by revising paragraph (a) to read as follows:


Sec.  120.882  Eligible Project costs for 504 loans.

* * * * *
    (a) Costs directly attributable to the Project including 
expenditures incurred by the Borrower (with its own funds or from a 
loan) to acquire land used in the Project, or for any other expense 
directly attributable to the Project, prior to applying to SBA for the 
504 loan;
* * * * *
0
10. Amend Sec.  120.920 by adding two sentences at the end of paragraph 
(b) to read as follows:


Sec.  120.920  Required participation by the Third Party Lender.

* * * * *
    (b) * * * The 504 loan is usually collateralized by a second lien 
on Project Property (``Common Collateral''). If the Third Party Lender 
requires a lien on collateral in addition to the Common Collateral, in 
the event of liquidation, the Third Party Lender must apply the 
proceeds from the sale of such additional collateral to the balance 
outstanding on the Third Party Loan prior to the application of 
proceeds from the sale of the common collateral to the Third Party 
Loan.


Sec.  120.925  [Removed]

0
11. Remove Sec.  120.925.

PART 121--SMALL BUSINESS SIZE REGULATIONS

0
12. The authority citation for part 121 continues to read as follows:

    Authority: 15 U.S.C. 632, 634(b)(6), 636(b), 662, and 694a(9).

0
13. Amend Sec.  121.103 by removing and reserving paragraph (a)(7) and 
adding paragraph (a)(8) to read as follows:


Sec.  121.103  How does SBA determine affiliation?

    (a) * * *
    (8) For applicants for 7(a) loans, 504 loans and microloans, 
affiliation is determined under Sec.  121.302 instead of this Sec.  
121.103.
* * * * *


Sec. Sec.  121.302 through 121.305  [Redesignated as Sec. Sec.  121.303 
through 121.306]

0
14. Redesignate Sec. Sec.  121.302 through 121.305 as Sec. Sec.  
121.303 through 121.306 and add a new Sec.  121.302 to read as follows:


Sec.  121.302.  Principles of affiliation to determine size of 
applicants for 7(a) loans, 504 loans, and microloans.

    (a) General principles of affiliation. Generally, affiliation 
exists when one concern controls or has the power to control another, 
or when a third party (or parties) controls or has the power to control 
both concerns. Control may arise through ownership, management, or 
other relationships or interactions between the parties. In determining 
an applicant's size, SBA counts the receipts, employees, or other 
measure of size of the applicant whose size is at issue and all of its 
domestic and foreign affiliates, regardless of whether the affiliates 
are organized for profit. The exceptions to affiliation coverage set

[[Page 12646]]

forth in Sec.  121.103(b) are incorporated into this section by 
reference. SBA will not consider negative control, by itself, as set 
forth in Sec.  121.103(a)(3) of this part to create affiliation under 
this section. In determining affiliation under this section, SBA will 
consider the totality of the circumstances to determine whether 
affiliation exists, even though no single factor may be sufficient to 
constitute affiliation.
    (b) Affiliation based on ownership. For determining affiliation 
based on ownership:
    (1) A concern is an affiliate of a person (including any 
individual, concern or other entity) that owns or has the power to 
control more than 50 percent of the voting equity of the concern. If no 
person owns or has the power to control more than 50 percent of a 
concern's voting equity, SBA will deem the Chief Executive Officer 
(CEO) or President of the concern (or other officers, managing members, 
partners, or directors who control the management of the concern) to be 
in control of the concern.
    (2) If any two or more persons (including any individual, concern 
or other entity) collectively own or have the power to control more 
than 50 percent of the voting equity of two or more concerns (the 
``collective owners''), then there is affiliation between such concerns 
and between each concern and each collective owner.
    (c) Affiliation arising under options, convertible securities, and 
agreements to merge. In determining size, SBA considers options, 
convertible securities, and agreements to merge (including agreements 
in principle) to have a present effect on the power to control a 
concern. SBA treats such options, convertible securities, and 
agreements as though the rights granted have been exercised.
    (1) Agreements to open or continue negotiations towards the 
possibility of a merger or a sale of stock or other equity at some 
later date are not considered ``agreements in principle'' and are thus 
not given present effect.
    (2) Options, convertible securities, and agreements that are 
subject to conditions precedent which are incapable of fulfillment, 
speculative, conjectural, or unenforceable under state or Federal law, 
or where the probability of the transaction (or exercise of the rights) 
occurring is shown to be extremely remote, are not given present 
effect.
    (3) An individual, concern or other entity that controls one or 
more other concerns cannot use options, convertible securities, or 
agreements to appear to terminate such control before actually doing 
so. SBA will not give present effect to individuals', concerns' or 
other entities' ability to divest all or part of their ownership 
interest in order to avoid a finding of affiliation.
    (d) Affiliation based on common management. Affiliation exists 
where the CEO or President of a concern (or other officers, managing 
members, partners or directors who control the management of the 
concern) also controls the management of one or more other concerns. 
Affiliation also arises where a single person or entity that controls 
the board of directors of one concern also controls the board of 
directors or management of one or more other concerns.
    (e) Affiliation based on franchise, license and similar agreements. 
If the applicant is a franchisee, licensee or other similar entity, the 
provisions of Sec.  121.103(i) apply.
    (f) Affidavit of applicant. Each applicant for a 7(a) loan or a 504 
loan must include as part of its application for financial assistance 
an Affidavit in which it discloses all owners of the applicant and 
their percentage of ownership and discloses any affiliates as 
determined under this section. The Affidavit must be executed by the 
applicant's CEO or equivalent.

    Dated: February 19, 2013.
Karen G. Mills,
Administrator.
[FR Doc. 2013-04221 Filed 2-22-13; 8:45 am]
BILLING CODE 8025-01-P