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SBA Offers Guidance on Affiliation Rules for Paycheck Protection Program

On April 3, the Small Business Administration issued two additional rule updates affecting the Paycheck Protection Program. First, it provided a summary of the affiliation rules to be used by applicants in connection with the PPP for the purpose of calculating an applicant’s total number of employees and determining its eligibility to participate in the program. It also published an Interim Final Rule describing an effective exemption from these rules for faith-based organizations (FBOs).

Affiliation Rules

The PPP is available to small business concerns (businesses that are independently owned and operated, organized for profit, and are not dominant in their field), 501(c)(3) nonprofits, 501(c)(19) veteran’s organizations and tribal business concerns with 500 or fewer employees (full and part-time), or not otherwise more than the specific NAICS size standard established for their industry, as made available by the SBA.

Under the preexisting SBA regulations, when determining the size of an applicant, the SBA includes the employees of the applicant and the employees of any “affiliate” of the applicant. Two entities are affiliates of each other when one has the power to “control” the other, or a third party has the power to “control” both.

The April 3 guidance provided clarity on the affiliation rules that apply to the PPP.

For purposes of the PPP, the SBA states that “control” may be present based on any of the following criteria:

  1. Affiliation based on ownership. Affiliation arises when one individual or entity controls the ownership of two or more entities. Generally, the owner of more than 50% of an entity’s voting equity controls that entity (counting options, convertible securities, and agreements to merge as though the rights granted have been exercised). In some cases, however, the SBA will deem a minority shareholder to be in control, if it has the contractual power (through the charter, by-laws, or shareholders’ agreement) to prevent a quorum or otherwise block action by the Board of Director or shareholders. Determinations of control by a minority shareholder are very fact specific.
  2. Affiliation based on management. Affiliation arises when one individual, group of individuals, or entity controls the management of two or more entities as a result of being an officer of such entities or by controlling the Boards of Directors. Affiliation also arises where a party controls the management of an applicant through a management or voting agreement that entitles that party to effectively control the applicant entity.
  3. Affiliation based on identity of interest. Affiliation arises when an identity of interest exists between “close relatives” (e.g., spouse, parent, child, sibling, or the spouse of any such person) with substantially identical business or economic interests, such as operating in similar industries in the same geographic area.  

In its April 3 guidance, the SBA also reiterated that the affiliation rules are waived in the Paycheck Protection Program for the following entities: (i) businesses in the accommodation and food services sectors (i.e., businesses with a NAICS code beginning in 72), (ii) franchises that are assigned a franchise identifier code by the SBA, and (iii) businesses that receive financial assistance from a Small Business Investment Company. As a result, these exempt businesses may apply for a Paycheck Protection Program loan if they have fewer than 500 employees, regardless of the number of employees of their affiliates.

In addition, in a letter dated April 4, 2020, the Associate General Counsel for Procurement Law at the SBA noted that while private equity, venture capital, and investment-backed companies are subject to the affiliation rules, it also reiterated that there is a blanket exemption from the affiliation rules for companies using a NAICS code beginning in 72. Therefore, restaurants and accommodation companies, regardless of their ownership and control, will be able to seek PPP loans for all of their locations, so long as such a business does not have greater than 500 employees in any location and the total amount of the loan requested does not exceed $10,000,000; all without regard to their affiliates’ size.

Impact on Faith-Based Organizations (FBOs)

Separately, in an Interim Regulation released on April 3, the SBA determined that the SBA’s affiliation rules, including those referenced above and set forth in 13 CFR 121, do not apply to FBOs to the extent they have affiliates as a matter of their sincere religious exercise. Therefore, as long as an individual FBO (e.g., a house of worship, convention or association of religious entities, or any organization associated therewith including charitable organizations that share a common religious bond or conviction with said house or warship, convention or association of religious entities) has no more than 500 employees (including any affiliates who are considered affiliates for “non-religious reasons”), it is eligible to apply for a loan under the PPP. The SBA has stated that it will not assess, and will not permit participating lenders to assess, whether an FBO’s affiliates are affiliates as a matter of sincere religious belief or not, leaving that determination up to the FBO’s reasonable determination.

The SBA found in its newly released rule that applying the standard affiliation rules to otherwise qualified FBOs would “substantially burden religious exercise” based on the Religious Freedom Restoration Act’s prohibition on the government placing a “substantial burden” on a person’s exercise of religion unless the government can demonstrate (i) a “compelling government interest” and (ii) that the government is using the least restrictive means of furthering that “compelling government interest.”

The SBA determined that some FBOs would qualify for relief under the CARES Act but for their affiliation with other entities as an aspect of their religious practice. Therefore, the SBA concluded that the affiliation rules would impose a “substantial burden” on the important benefits provided for under the CARES Act (specifically the PPP) and that there is no “compelling government interest” in denying emergency assistance to FBOs.

As a result, the SBA is exempting from its standard affiliation rules, FBOs whose affiliations are a matter of their “sincere religious exercise” as defined in 42 USC 2000bb-2 (i.e. an exercise of religion, whether or not compelled by, or central to, a system of religious belief). Accordingly, FBOs with not more than 500 employees or, if applicable, the size standard in a number of employees established by the SBA for the industry in which the FBO operates, can qualify for a loan under the PPP even if, due to its sincere religious exercise, the FBO has affiliates who would otherwise put the FBO over the limit of the PPP’s size requirements.

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