Primary purpose of Franchise revisions is to streamline procedures for determining size eligibility based on affiliation between Franchisee & Franchisor Regulatory Changes 13 CFR 121.301(f)(5) (effective July 2016) Affiliation based on franchise and license agreements. The restraints imposed on a franchisee or licensee by its franchise or license agreement generally will not be considered in determining whether the franchisor or licensor is affiliated with an applicant franchisee or licensee provided the applicant franchisee or licensee has the right to profit from its efforts and bears the risk of loss commensurate with ownership. SBA will only consider the franchise or license agreements of the applicant concern. 2
New procedures apply to all SBA applications on or after 1/1/2017, per SOP 50 10 5(I) Franchise and License Agreements SOP 50 10 5(I), page 228 SBA Policy Notice 5000-1941, effective February 14, 2017 Apply to agreements/relationships: Small Business Applicant ONLY not affiliates Projects that meet Federal Trade Commission (FTC) Franchise definition in 16 CFR 436 Covered by Petroleum Marketing Practices Act (PMPA) e.g., gas stations 3
New Franchise Review Guidance NEW SBA has eliminated the need for SBA to: 1. Review franchise and license agreements to determine affiliation between franchisor and franchisee 2. Maintain an internal or external centralized listing of franchise systems where the franchisor and franchisee are not considered affiliated 3. Maintain an internal or external centralized listing of franchise findings 4. Utilize the Franchise Registry or FRUNS numbering system NO CHANGE To be eligible for SBA financing, Applicant must: 1. Be independently owned/operated, small, and not dominant in its field 2. Have right to profit from its efforts and bear risk of loss commensurate with Ownership 4
Franchise means any continuing commercial relationship or arrangement, whatever it may be called, in which terms of offer or contract specify, or franchise seller promises or represents, orally or in writing, that: a. Franchise will obtain the right to operate a business that is identified or associated with the franchisor s trademark, or to offer, sell, or distribute goods, services, or commodities that are identified or associated with the franchisor s trademark; b. Franchisor will exert or has authority to exert a significant degree of control over the franchisee s method of operation, or provide significant assistance in the franchisee s method of operation; and c. As a condition of obtaining or commencing operation of the franchise, the franchisee makes a required payment or commits to make a required payment to the franchisor or its affiliate. Agreement/Relationship must meet all three elements of the franchise definition to be deemed a franchise. Agreement/Relationship CAN meet FTC franchise definition even if not called franchise -- e.g. Best Western = membership agreement 5
The first element of a defined Franchise relationship is characterized by the use of the Franchisor s trademark, even if the trademark is not registered. According to FTC guidance, the term trademark is intended to be read broadly to cover not only trademarks, but any service mark, trade name, or other advertising or commercial symbol. Note, the definition says the franchisee has the right to operate a business that is identified or associated with the franchisor s mark; it doesn t have to actually be used. Also, if the franchisee is specifically prohibited from using the mark, then the arrangement does not meet the FTC definition. 6
The second element defining a Franchise relationship is the issue of control. Again, according to the FTC, in order to be deemed significant, the control or assistance must relate to the franchisee s overall method of operation not a small part of the franchisee s business. Control or assistance involving the sale of a specific product that has, at most, a marginal effect on a franchisee s method of operating the overall business will not be considered in determining whether control or assistance is significant. Examples of control that may be deemed significant include: site or location approval; specification of site design or appearance requirements; specified hours of operation; specified production techniques; and mandated accounting practices. On the other hand, promotional activities without additional forms of assistance, generally will not be deemed significant. For additional examples of what activities the FTC may consider significant, see the FTC Franchise Rule Compliance Guide at https://www.ftc.gov/system/files/documents/plainlanguage/bus70-franchise-rule-compliance-guide.pdf. 7
The third element to the FTC definition is payment to the franchisor or its affiliate of at least $500 any time prior to or within the first six months of the commencement of operations of the franchised business. According to FTC guidance, the term payment is intended to be read broadly, capturing all sources of revenue that a franchisee must pay to a franchisor or its affiliate for the right to associate with the franchisor, market its goods or services, and begin operation of the business. (FTC Franchise Rule Compliance Guide, pg. 5.) Examples of required payments include: initial franchise fee; rent; advertising assistance; equipment and supplies (including such purchases from third parties if the franchisor or its affiliate receives payment as a result of the purchase); training; security deposits; escrow deposits; non-refundable bookkeeping charges; promotional literature; equipment rental; and continuing royalties on sales. The term does not include, however, payments made for reasonable amounts of inventory at bona fide wholesale prices for resale or lease to the public. Every payment that is made, no matter what it purports to be for or what it is called, is subject to being classified as a franchise fee. Therefore, the CDC should carefully analyze each payment that the Borrower expects to pay or has paid to the Franchisor in determining whether any of the payments are considered a franchise fee under the third element of the definition. 8
Guidance for Applicants with Multiple Agreements at one location (e.g., Independent insurance agents, Independent tire retail stores, etc.): 1. Review agreements do any meet the FTC definition of franchise? 2. How much of the applicant s revenue do the agreements meeting the FTC definition of franchise constitute? 3. Determine whether any agreement/relationship which meets the FTC definition of franchise constitutes a critical portion of applicant s revenue 4. For any agreement deemed critical, CDC must obtain all Required Documentation and follow Franchise Review Process. CDCs must continue to ensure that all aspects of the project are eligible business types, despite the percentage of revenue they generate. 9
1. Copy of Franchise Agreement 2. SBA Addendum to Franchise Agreement (SBA Form 2462) OR Temporary Alternative Documentation: Certification (SBA Form 2463) and SBA Negotiated Addendum (ONLY available when SBA and Franchisor have previously negotiated addendum specific to 2015 or 2016 franchise agreements) o o o Addendum/Temporary Alternative Documentation overrides franchise agreement provisions in conflict with SBA requirements Only addresses affiliation between Franchisor and Franchisee No alterations allowed to SBA Form 2462, SBA Form 2463, or an SBA Negotiated Addendum 3. Any related documents of which the franchisor requires the franchisee to sign or acknowledge receipt (For example: Purchase Option Agreements, SNDAs, Lease Option Agreements, Covenants and Deed Restrictions, and Right of First Refusal documents) 10
11 Form now includes option to allow the entity to select the appropriate type of agreement and the proper titles of the parties to the agreement.
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NO CHANGE CDC is still responsible for reviewing agreement(s) to ensure applicant meets all SBA eligibility requirements Franchisee is an eligible business type e.g., Not passive business, no restrictions on patronage Specific prohibited collateral restrictions e.g., No deed restrictions in Purchase Contract, restrictions in Dealer Agreements 13
1. CDC determines whether applicant is a franchise/meets FTC definition of Franchise 2. CDC reviews agreement(s) and all related franchise documents for Eligibility Issues 3. CDC obtains Addendum to Franchise Agreement (or Temporary Alternative documentation, if applicable) 4. Pre Application Review Request to SLPC via e504 Include all Required Documentation, whether executed or not 5. SBA reviews documentation and, if all franchise documentation is approved, SBA issues franchise approval/clearance* to CDC *Disclaimer Issuance of franchise clearance does not constitute loan approval 14
6. CDC submits 504 Loan Application Include franchise clearance from Pre-App Review in Exhibit 13 (Form 1244) 7. SLPC reviews application. If approved, provides Loan Authorization When all Required Franchise Docs are executed SLPC sends approval notification to CDC When all Required Franchise Docs are NOT executed SLPC inserts Franchise Doc requirement language in the Authorization PCLP CDC manually inserts language in Authorization 8. 327 Action prior to 504 loan closing Required if documentation is not executed at Pre Application Review step All executed documentation submitted to SLPC via 327 Amendment 327 Amendment approval meets franchise condition of Authorization CDC must obtain executed Franchise Agreement(s) and Addendum(s) BEFORE Interim Loan is funded, in order to protect Interim Lender. 15
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Q2: Are Addendums loan specific? Should CDC add loan number to Addendum? No. The Addendum is valid for the life of the specific Franchise Agreement and can be used for multiple loans to that applicant. Q3: If the franchisor signs an Addendum and there is another 504 franchise loan with the same borrower, can they use same addendum? Yes. However, if there are multiple locations of the franchise, each location s application must have an Addendum provided with the application. If they are operating under the same Franchise Agreement, they only need one addendum. If each location utilizes a different franchise agreement, you must have the specific addendum for that version of the franchise agreement for which they are obtaining a loan. The CDC should ask if there is more than one version of this franchise concept and how/why it varies. 18
Q4: What does SBA review the agreement for during the Pre-App Review? SBA reviews the agreement for eligibility purposes and to confirm that the SBA Addendum (or Temporary Alternative Documentation) is included. Further review may be required if SLPC has further questions resulting from info in CDC credit memo at time of full loan application. Q5: May I submit my loan application to SLPC without submitting a Pre-App Review? No. SLPC will screen out any loan application identified as a franchise (or other agreement that meets the FTC definition of franchise) that has not been cleared through a Pre-Application Review. 19
Q6: What is the process for a new franchise concept that does not have a Franchise Identification number? SLPC requests issuance of a Franchise Identification Number from the Office of Financial Assistance if a franchise is new or does not have a Franchise Identification Number. SLPC will need the Franchise Disclosure Document (FDD) pages sufficient to provide these answers: a) Legal name of franchisor b) Trade name or d/b/a of franchise system c) Issuance Date of the specific/current FDD d) State of Organization for the Franchisor For Dealer/Fuel or jobber agreements that do not issue an FDD, provide all documentation of which the licensor/dealer is required to execute or acknowledge receipt, so SBA can determine if it meets the FTC legal definition of a franchise. 20
Q7: Do the franchise review procedures apply to gas stations and Fuel Distribution/Dealer/Jobber/License Agreements? Yes. All agreements and relationships that are covered by the Petroleum Marketing Practices Act (PMPA), 15 U.S.C. 2801 (e.g., gas stations), are included within the FTC definition of franchise and are subject to the new franchise procedures in SOP 50 10 5 (I) and Policy Notice 5000-1491 (effective 2/14/17), including but not limited to requiring the SBA Addendum to Franchise Agreement (SBA Form 2462) or Temporary Alternative Documentation. A related issue to fuel agreements arises when the gas station includes a convenience store. If the convenience store is covered under the same agreement as the fuel sales, then only one Addendum will be required. If, however, there is a separate agreement covering the convenience store (or any additional franchise operation inside the convenience store), then a separate Addendum will need to be obtained for the fuel agreement and the agreement that governs the convenience store (and any other franchise inside the c-store) if they meet the FTC definition of Franchise. In all cases, if there are other documents the distributor/licensor/dealer requires the small business applicant to sign, the CDC must review those documents to ensure compliance with all SBA Loan Program Requirements. 21
Q8: What about Non-Fuel Dealer/Distribution/Jobber/License Agreements? For distributor/license/dealer/other agreements and relationships that don t involve the sale of fuel, the CDC will have to review the agreement and any other documents the small business applicant is required to sign in order to determine if the agreement meets the FTC definition of a franchise. The agreement or relationship must meet all three elements in order to be deemed a franchise ; if the agreement or relationship does not meet all three elements of the definition, then it is not a franchise and is not subject to the new procedures. Q9: Are Area Development Agreements eligible? Area Development Agreements MAY be eligible. These agreements allow a specific franchisee to operate a number of franchises within a specified geographic area. They are not eligible if agreement allows the developer to use outside franchisees to open locations in their territory. (See guidance in franchise section of SOP 50 10 5(I), page 228 type of business, restrictions, etc.) Franchise Development Agreements aka Master Franchise Agreements are INELIGIBLE. These agreements are considered passive investments and/or inherently speculative. The Agreements provide geographic territory to grow more franchise units and developer s income consists of royalty payments from independently owned franchise units. 22
Q10: What if a Franchisor refuses to sign the SBA Addendum to Franchise Agreement (SBA Form 2462) or temporary alternative documentation? If the agreement meets the FTC definition of a franchise and the Franchisor refuses to execute the SBA Addendum to Franchise Agreement (SBA Form 2462) or the Certification (SBA Form 2463) with SBA Negotiated Addendum, the loan is ineligible. Further, if the CDC fails to obtain the executed Addendum to Franchise Agreement prior to closing, the 504 loan may not be closed or funded. If the Franchisor refuses to sign the SBA Addendum because they do not want to forgo their Right of First Refusal (ROFR): The Addendum does not prevent the franchisor from having the Right of First Refusal (ROFR). By signing, they agree only that they will only exercise such an option if the proposed transferee is not a current owner or family member of a current owner of the Franchisee. This means if two owners own a franchise and one owner wants to sell his/her shares to the other owner, the Franchisor will not exercise their ROFR to transfer complete ownership to the franchisor. The same conditions apply to transfers of ownership to family members of the owners, such as father to son, etc. 23
Q11: What language is required in the loan Authorization? SBA recognizes sometimes an addendum may not be executed prior to SBA s loan approval. In those cases SBA allows a CDC to submit the loan application without the executed addendum, provided the executed documents are obtained prior to closing a 504 loan. The updated language must be manually inserted into the Authorization Boilerplate. For CDCs the SLPC will insert the following language in the 504 Debenture Authorization: Franchise - CDC must obtain the executed Franchise Agreement, either (i) the SBA Addendum to Franchise Agreement (SBA From 2462), or (ii) the Certification (SBA Form 2463) and SBA Negotiated Addendum, and all other documents the franchisor requires the franchisee to sign. PCLP CDCs will have to insert the language in the Debenture Authorizations themselves. The language can be manually inserted into the prior to closing section of the 504 Authorization Boilerplate by clicking Edit and adding the language above. 24
Send questions on Franchise updates to temporary email box: FranchiseFY2017@sba.gov 25