Second Round of PPP Funding Comes with New Rules for Franchises – Are You Ready?

On April 23, 2020, the House passed the Paycheck Protection Program Increase Act of 2020 after the Senate unanimously passed the legislation on April 21. The new act adds an additional $310 billion to fund the Paycheck Protection Program (PPP) under the Coronavirus Aid, Relief and Economic Security Act (CARES Act). President Trump has committed to signing the act into law. The act sets aside $60 billion for community-based and smaller lenders to assist smaller businesses that were unable to access PPP funds during the first round of loans.

Following the implementation of the PPP, the SBA created a new Franchise Directory category, applicable solely to PPP loans. Last week, the SBA and Treasury Department issued new guidance concerning the eligibility of franchised businesses for PPP loans.

Overview of the PPP

The CARES Act allocates a significant amount of federal funds to cover eight weeks of payroll and overhead expenses for small businesses through the PPP. The SBA guaranteed $349 billion in PPP loans for small businesses of not more than 500 employees (with some exceptions) to maintain their payroll during the pandemic. These loans have very favorable terms, including loan forgiveness for eight weeks of payroll and overhead expenses, first payment deferral for six months, no collateral, no personal guarantees, no borrower or lender fees payable to the SBA, and 100% guarantee by the SBA. Small businesses may borrow up to $10 million, with interest not to exceed 0.5%, and maturity of 2 years. These features make the PPP akin to an emergency grant program for small businesses to fund their payroll during the pandemic.

Because of overwhelming demand from businesses applying for loans through the PPP since the program’s April 3, 2020 launch, last week the PPP ran out of funds. This prompted Congress to develop a plan to replenish the funds to continue the program.

Eligibility for franchised businesses: the affiliation test

Eligibility for the PPP is limited to borrowers with not more than 500 employees. However, if the business has more than 500 employees, it may still be eligible if it meets the employee-based or revenue-based standard for the business’s industry as set forth in the Small Business Act.

Traditionally, the SBA has used an “affiliation” test to assess whether a business’s affiliates will be considered part of the same entity in order to determine eligibility for SBA-administered loan programs (i.e., whether the entity is a small business concern or, in this case, has more than 500 employees). According to the SBA, “affiliation exists when one business controls or has the power to control both businesses. Control may arise through ownership, management, or other relationships or interactions between the parties.”

The CARES Act contains a specific affiliation test exemption for franchised businesses (franchisors and franchisees alike) seeking relief as part of the PPP. Under the PPP, a franchised business will not be aggregated if the franchise program has been assigned a franchise identifier code by the SBA (i.e., the franchise system is listed on the SBA Franchise Directory).

New PPP Franchise Directory category

There are now two separate categories on the SBA Franchise Directory: 1) the traditional category, applicable to SBA 7(a) loans and PPP loans; and 2) the new category, applicable solely to PPP loans.

To be listed on the SBA Franchise Directory under the traditional category, the SBA conducts an “affiliation” assessment (separate from the “affiliation” test discussed above) to determine eligibility (i.e., whether the entity is a “small business concern”).

Franchisees may be deemed affiliated with their franchisors, or vice versa, where the franchisor exercises what the SBA deems to be significant control over the franchisee’s business. These controls may relate to, among other things, the franchisor’s step-in rights to manage day-to-day operations; the franchisor’s ability to hire, fire, or schedule the franchisee’s employees; and the franchisee’s freedom to transfer and sell the business.

Listing on the SBA Franchise Directory under the traditional category is obtained through an application by the franchisor. The franchisor must typically submit its franchise agreement and FDD. In lieu of submitting its franchise agreement, the franchisor may agree to use a form SBA addendum to the franchise agreement, which removes the disqualifying control provisions from the franchise agreement, to bypass the affiliation determination and be added to the SBA Franchise Directory. Alternatively, the franchisor may negotiate the terms of an addendum with the SBA, removing the disqualifying franchise agreement provisions.

The SBA has added a new category of franchised businesses to the SBA Franchise Directory that will be listed solely for the duration of the PPP. This new category is used only to determine eligibility for PPP loans, and not any other SBA-administered loans. Franchisors in this category do not have to amend their franchise agreements to remove the controls that would otherwise create a disqualifying affiliation.

The SBA reports it is processing SBA Franchise Directory requests “as quickly as possible” and still requires a franchisor who wants its brand on the SBA Franchise Directory under either category to submit its franchise agreement and FDD. However, the SBA is conducting expedited reviews and not undertaking the affiliation assessment for franchisors in the new category.

If a franchised business is not listed on the SBA Franchise Directory, the SBA’s affiliation rules will apply to determine whether the franchised business will be aggregated for purposes of determining PPP eligibility. If affiliation is found within a franchise system, the businesses will be aggregated. As a result, franchisors and franchisees may be disqualified from obtaining relief under the PPP, or the franchisors and franchisees may face delays in the application process as a result of having to challenge the affiliation determination if the franchised business is not listed on the SBA Franchise Directory.

The application process for a PPP loan will be streamlined if the franchised business receives an SBA franchise identifier code, so it is advisable for franchisors not on the SBA Franchise Directory to register as soon as possible.

New PPP guidance for franchised businesses

The April 13, 2020 guidance clarifies that each franchise entity within a franchise system listed on the SBA Franchise Directory may apply for a PPP loan. Listing on the SBA Franchise Directory exempts only the franchise entity from the PPP affiliation test; each franchise entity still must meet the eligibility requirements for a small business to participate. If a franchised business previously applied to be on the SBA Franchise Directory but was denied because the SBA found affiliation between franchisors and franchisees, the franchisor may request to be listed on the SBA Franchise Directory’s new PPP category.

How do I apply?

Businesses may apply for the PPP through any existing SBA 7(a) lender or other participating financial institution from now until June 30, 2020, but the SBA has warned in its Interim Final Rule on the PPP that the loans are first-come, first-served. As recent events have demonstrated, funds are being allocated very quickly. The PPP Borrower Application Form is available here.

Jan Gilbert is a Shareholder with Polsinelli and Emily Doan is an Associate with the firm. Both focus on the firm’s Global Franchise and Supply Network. Contact him at 202-777-8918 or jgilbert@polsinelli.com. Contact her at 303-256-2702 or edoan@polsinelli.com.