Tag: SBA

SBA finalizes rule limiting consideration of criminal history in loan programs

Today, the Small Business Administration’s rule removing most criminal history restrictions in its federally guaranteed loan programs will be published in final form. This marks an important step in opening additional sources of business capital to justice-impacted entrepreneurs, and a boon to developing communities that thrive on the success of their small businesses. The final rule makes few changes from the version published last fall for comment, which proposed removing most criminal history restrictions from the SBA’s business and disaster loan programs. The proposed rule is described in this post. The only substantive difference in the final rule is that business owners under indictment, along with those actually incarcerated, will remain ineligible for federally guaranteed loans. The SBA noted that of the 19 comments received on the proposed rule, almost all were favorable. It also pointed out, as it did last fall, that there is no data indicating an enhanced risk of default from this population of entrepreneurs. At the same time, the SBA comments that even though it will no longer be conducting extensive criminal records checks on loan applicants, lenders may continue to do so. In describing the background of the now-final rule, the SBA cites some eye-catching statistics indicating that in recent years it has been giving lenders the green light on hundreds of loan applications from business owners with a felony record, while disapproving only a handful. These statistics, which are consistent with the SBA’s responses to FOIA requests with which CCRC is familiar, would seem to indicate that the SBA has available to it data that could shed light on actual risk through default rates.  We look forward to learning more about this data, which could give banks additional incentives to make loans to justice-impacted entrepreneurs. We have recently attended several programs sponsored by the Treasury Department and its agencies in which the issues raised by “fair chance lending” have been explored, and we expect to be continuing that conversation in weeks to come.   Read more

SBA modifies criminal history restrictions in its loan programs

We have written at length about the broad criminal history restrictions imposed by the U.S. Small Business Administration in its business loan and disaster assistance programs. These restrictions, which first came to the public’s attention during the pandemic, have limited the availability of federally guaranteed bank loans to small businesses in developing communities, and stymied efforts to close the racial wealth gap through minority entrepreneurship. The SBA’s restrictive lending policies have never been justified by empirical evidence linking criminal history and creditworthiness, and may raise issues under the federal Equal Credit Opportunity Act.  It now appears that those policies are under review within the agency. Several weeks ago we reported on the SBA’s proposal to amend its rules on lending criteria to eliminate language that the agency has relied on for many years to support policies restricting federally guaranteed loans based on a business owner’s criminal history. In commenting on the proposed rule, we expressed the hope that this rule change would augur and end to the SBA’s consideration of  criminal history as an independent basis for denying credit. The SBA’s proposed amendment became final on April 10. While we remain guardedly optimistic that the new rule will have the hoped-for effect where the SBA’s own policy and practice is concerned, at the same time the agency’s comments accompanying the final rule seem to signal an expectation that banks will still consider a loan applicant’s criminal history in deciding whether to make a loan even if the agency does not. It appears that we will have to wait for the agency to issue implementing procedures and revised application forms before the full effect of this rule change can be assessed. [See the note at the end of this comment for subsequent SBA changes in its operating procedures.] The final SBA rule covers a variety of subjects related to its guaranteed loan programs — notably expanding the range of financial institutions that will be authorized to make SBA loans.  But its key provision from CCRC’s perspective is its omission of the words “character” and “reputation” from the lending criteria specified in 13 CFR 120.150(a). It is this language that has been relied on in SBA operating policies to limit eligibility for both business loans and disaster assistance to business owners who have a criminal history.  This is because the SBA’s operating procedures have in past years required loan applicants to have “good character,” defined exclusively in terms of an applicant’s criminal history.  (The SBA imposes similar criminal history restrictions in its federal contract preference program, where they are similarly justified in terms of an applicant’s necessary “good character.”) In comments describing the new rule, the SBA explains why it relies on a “good character” standard: “For SBA, ‘character’ is used to determine whether an individual may have past criminal history or activities that may pose a risk to repayment ability.” 88 Fed. Reg. 21077. This is not the first time that the SBA has proposed that “past criminal history” may present an independent credit risk. See Defy Ventures v. U.S. Small Bus. Admin., 469 F. Supp. 3d 459, 476 (D. Md. 2020)(“The SBA explained that the criminal history exclusions were based on ability to repay . . . and potential for misuse of funds.”). While the SBA’s comments express a preference for “objective measures” in assessing credit risk that result in “less variability” than criteria like character and reputation that are “subject to individual interpretation,” at the same time they propose that “SBA Lenders may continue to make their own credit decisions based on the criminal background of an applicant and its associates.” 88 Fed. Reg. 21077. Stepping back to assess the effect of the new rule, the good news is that it appears the SBA will no longer bar banks from making loans to otherwise qualified applicants based on their criminal history. The less good news is that the agency seems to expect banks and other lending institutions to step into the void and apply their own restrictions on loans based on an applicant’s criminal history. We do not know whether, left to their own devices, private lenders would disqualify loan applicants based on criminal history alone, or what standards lenders will apply without the guidance and protection afforded by the SBA “good character” policies.  There does not appear to be any industry-wide standard to guide banks and other financial institutions in their business lending policies, though we hope they are beginning to consider these issues. The SBA also took the opportunity in these comments seemingly to reaffirm its existing rule making a business ineligible for a federally guaranteed loan if any 20% owner is on probation or parole, in prison, or has unresolved criminal charges.  Id., citing 13 C.F.R. 120.110(n). It remains to be seen if the SBA will take further actions to facilitate borrowing by justice-affected entrepreneurs, notably what guidance will offer to its approved lenders in their “credit decisions based on the criminal background of an applicant.”  At present, the SBA’s operating procedures now include broad inquiries about loan applicants’ past criminal history and mandatory FBI background investigations, but no formal standards for its “good character” determinations. Until we see whether and how the SBA plans to amend the administrative mechanisms through which it has historically enforced its own criminal history restrictions, we cannot determine the full implications of its elimination of “character” as a formally applicable loan criterion, including what standards banks will be encouraged to apply in considering criminal history as an independent measure of creditworthiness. NOTE, 7/25/23: Since this analysis was published in April, the SBA issued revised operating procedures (SOPs) governing its 7(a) and 504 loan programs that omit the “character determination” that has in the past acted to winnow out many otherwise qualified loan applicants. This new SOP is to be effective August 1, 2023. In addition, shortly after the “affiliation” file became final, the SBA indicated an intention to propose yet another rule governing its small business loans, to eliminate most inquiries about criminal history on the application form, instead asking “a straightforward question on incarceration and verifying the response using a third-party database check.” The SBA described this change in policy as “continu[ing] to allow SBA lenders to follow their own policies on criminal background checks.” As of July 25, 2023, the SBA had not issued this proposed additional rule, and the application forms for 7(a) loans containing extensive inquiries about criminal history had not been amended. On May 16, 2023, the chairs and ranking members of small business committees in the House and Senate wrote to the Administrator of the SBA asking her to “pause” the new rule until a new head of the SBA’s office responsible for implementing the new rule could be appointed. We understand that as of July 25 no response to this letter had been received. Read more

Pending federal reforms promise support for justice-affected entrepreneurs

Word is getting around about pending reforms that would make federal support for small businesses more widely available to entrepreneurs with a criminal history. Notably, the U.S. Small Business Administration has recently taken steps to reduce or remove entirely criminal record-related restrictions in its loan and contracting programs.  These are steps that CCRC has been urging ever since the SBA’s restrictive policies first came to public attention during the pandemic. An article by Michael Friedrich published today by Arnold Ventures (AV) describes a number of reforms recently proposed or adopted by the SBA that will eliminate arbitrary program barriers based on criminal history that are unrelated to any established risk. These reforms should encourage more justice-affected business owners to seek SBA support for their entrepreneurial ventures in the form of federally guaranteed loans or federal contract set-asides for “socially and economically disadvantaged” businesses. The AV article points out that the near-exclusion from these programs based on criminal history “frustrate[s] federal efforts to contribute to economic development in disadvantaged communities, often the same low-income communities of color that have suffered the most during the era of mass incarceration and tough-on-crime policies.”     The AV article showcases the situation of Sekwan Merritt, whose electrical contracting company has become established in Baltimore since his release from prison five years ago, through small loans from a local community development organization, but which now needs the more substantial financial support provided by SBA loans to expand. “Entrepreneurs like Merritt, who have previously been involved with the justice system, often start small businesses as a response to discrimination and exclusion by traditional employers; around 4% of all small businesses have an owner with a criminal conviction. But they face dire challenges when trying to access capital through the SBA, the federal agency that connects small businesses with lenders to help them launch and develop. Merritt describes coming home from prison with a desire to start his own business and   “make things easier for people who have been through the same thing I have” by hiring others reentering the community after a prison term. His business, Lightning Electric, has grown steadily since that time, surpassing $600,000 in revenue last year. But when Merritt tries to take out small business loans, he hits a brick wall because of his criminal record. The Small Business Administration (SBA) and other institutional lenders have routinely denied him, making it difficult to hire and take on larger contracts.” Merritt believes that a change in the SBA’s policy “would create a seismic shift for his business, and for many others, making it possible to grow larger, take on more business, and contribute to their communities.”  Carson Whitelemons, director of criminal justice at AV, points out that “t]he SBA guaranteed more than $44.7 billion in loans in 2021 and serves as a particularly important lender for disadvantaged communities.”  CCRC’s Margaret Love notes that the capital controlled by the SBA “is critically important to helping people with a criminal record establish themselves in the community and to closing the racial wealth gap.”  Shawn Bushway, who has done extensive research on criminal records and employment, argues that ​“Places that have high crime, poverty, and other issues have fewer businesses than they could, and one reason may be that the people who want to develop businesses can’t get a loan.” Awesta Sarkash of the Small Business Majority adds that “entrepreneurship is a proven pathway to decrease recidivism,” and justice-affected business owners “should not be further marginalized or perceived as a credit risk simply because of their past.”  Research is underway that promises to support and encourage the reforms contemplated by the SBA, reforms that in turn should influence the policies of banks and other lending institutions. A group of researchers at the University of Michigan Law School is currently studying the effects of SBA laws, rules, and regulations on access to capital and entrepreneurship more broadly. They are particularly interested in the willingness of people with criminal records to apply for loans. J.J. Prescott, Henry King Ransom professor of law at the university, notes that such rules are likely to deter people with criminal records from starting businesses and submitting loan applications in the first place. The rules also sway other institutional lenders to employ similar restrictions. “The SBA influences the norms of the industry and gives the broader private market a justification for also looking at criminal records as a way to judge creditworthiness,” Prescott says. ​“Once you have a policy like this in place, there is a bit of a domino effect.” Prescott further notes that people’s criminal records have no clear impact on whether they repay loans, according to research. We will report in this space on further developments in the various SBA reforms proposed or foreshadowed. We hope that the spirit of reform that is seemingly moving the SBA in connection with its 7(a) loan program will in time be extended to its 8(a) business development and disaster assistance programs, which contain essentially the same criminal history-related restrictions.   Read more

Applying for federal disaster assistance with a criminal record

In addition to its lending and other programs in support of small businesses, the U.S. Small Business Administration provides long-term low-interest loans under Section 7(b) of the Small Business Act directly to individuals, businesses, and nonprofits in declared disaster areas. The current devastation wrought by Hurricane Ian in Florida — the subject of a dedicated new page on the SBA’s website — reminded us of some research we published two years ago, at the height of the pandemic, about how people with a criminal record were faring under the SBA’s COVID-related disaster relief program.  The answer initially was “not well.” Our research indicates that neither FEMA (emergency aid) nor the USDA (farm loans) impose criminal record restrictions on disaster assistance.  But the SBA does.  What’s more, the SBA’s restrictions are not formalized in a regulation but buried in operating procedures. The criminal history restrictions on SBA economic injury disaster loans (EIDL) under the CARES Act were initially even more restrictive than those that applied to its PPP relief, and they too were never formalized in a rule. The PPP restrictions were rolled back in response to public outcry and lawsuits, and the following year the COVID-related EIDL policy was also rolled back to disqualify the same limited population as the PPP itself (people in prison or on probation or parole, with pending felony charges, or with recent financial fraud and related convictions).  However, criminal record restrictions in the SBA’s general non-COVID lending programs, including its general disaster assistance programs, were not affected. Now that the SBA’s disaster assistance programs are no longer administered under the exceptional and well-publicized approach of the pandemic-related authorities, we thought it would be timely to take another look at how those programs — presumably including the one that specifically applies to Hurricane Ian relief — are available to people with a criminal record.     At the outset, it is worth noting that the federal government delivers immediate emergency aid to victims of disasters through FEMA, which appears not to ask about criminal record in any of its programs. FEMA refers individuals to the SBA for longer term assistance for physical and economic injury, but will resume some aid if someone is ineligible for an SBA disaster loan.  We don’t know how often this occurs, or what the process is for interagency coordination in such cases. A person will seek out an SBA disaster loan after the immediate stages of a disaster, to rebuild property or compensate for lost business income. By statute and rule, SBA is barred from making 7(b) disaster loans to persons who have been “convicted, during the past year, of a felony during and in connection with a riot or civil disorder or other declared disaster.” But the SBA’s operating policy on disaster loans is far broader than this narrow formal bar. In addition to barring assistance to anyone on parole or probation, the policy states the general principle that “It is not in the public interest for SBA to extend financial assistance to persons who are not of good character.” SOP 50 30 9 (3.6) (effective May 31, 2018) at p. 32. Like its policy on business lending, the SBA’s disaster assistance policy measures a person’s “good character” exclusively in terms of whether or not they have a criminal record. The SBA’s policy on disaster assistance disqualifies at the outset anyone who is “presently on parole or probation following conviction of a serious criminal offense.” Moreover, if an applicant discloses a prior criminal record in response to questions on the obligatory SBA Form 912, “Statement of Personal History”, the SBA must “make a determination as to the applicant’s character before a loan can be approved.” A potentially disqualifying record includes not only convictions but also diversions and guilty pleas and any form of probation at any time in the past, as well as unpaid fines and fees.  A detailed explanation about the records must be provided, and an application for disaster assistance can be processed without an FBI background check only if the disclosed criminal activity “is both minor in nature and was committed more than 10 years ago.” Otherwise, an FBI background check must be completed. (It is worth noting that the analogous SBA operating policy that applies to bank lending requires a background check only if the disclosed criminal activity is more serious than a misdemeanor.) Finally, after the background check is completed the SBA will make a determination of whether the person is “of good character” and therefore deserving of assistance.  The SBA’s practice of conducting background checks more broadly for disaster loans than for general small business loans is notable, especially in light of the lack of specific authority in the applicable authorizing statute. If minor criminal conduct (including misdemeanors and diversions) occurred within the previous ten-year period, or if criminal conduct is judged not to be “minor in nature” (a category not defined in publicly available documents as far as we can tell), it must be the basis of a fingerprint background investigation and may be the occasion for disqualification based on “unsatisfactory character.” That strikes us as a very tough standard to apply to disaster assistance, and will have particular applicability in urban settings that tend to have a large number of people with a criminal record. We plan to conduct further research into how the SBA is currently applying the restrictions in its operating policy on disaster assistance to those with a criminal record, and we welcome communications from anyone who has had relevant experience in this regard.       Read more

SBA proposes rules affecting businesses owned by veterans with a record

Over the past two years, CCRC has been studying the restrictions imposed by the U.S. Small Business Administration on loans to small businesses owned by justice-affected individuals. Many of those same restrictions, which are grounded in an operating policy that recipients of federal assistance have “good character,” also apply by formal rule in the SBA’s business development program under 8(a) of the Small Business Act. For more than half a century, the so-called “8(a) program” has earmarked federal contracts for businesses owned by socially or economically disadvantaged individuals, and it has been a key driver of community development in urban areas. But the program’s “good character” test has historically excluded from participation many if not most business owned or managed by individuals with a criminal history. The 8(a) program also has satellite programs, including ones offering preferential treatment to businesses owned by women and veterans, though it is less clear whether these programs have similar criminal history restrictions. Recently, Congress returned responsibility for certifying program eligibility for veteran-owned business from the VA to the SBA, and the SBA has now published proposed certification rules for public comment. These proposed rules offer a first chance to speak to the SBA’s “good character” requirement. CCRC worked with the Washington Lawyer’s Committee for Civil Rights to draft comments on the proposed rule that are critical of the SBA’s vague and open-ended test of business owners’ “character” that results in disqualification of many deserving individuals from this and other federal programs administered by the SBA. Those comments, which are joined by 24 other organizations, were filed on August 5 and are available here. The comments commend the SBA’s proposal to extend eligibility for certification to veteran business owners who are on probation or parole, or incarcerated.  However, they express concern that these individuals – along with others with a criminal history who have fully served their sentences — may be arbitrarily excluded from a program specifically intended to benefit them: The proposed removal of categorical exclusions for those on parole, probation, or who are incarcerated is an important step. However, the Proposed Rule’s continued use of “good character,” as well as the absence of any substantive or procedural criteria to guide decision-making, will continue to deny certification to individuals with significant business ability who otherwise could effectively and responsibly perform federal government contracts and contribute to the development of their communities. The comments are also critical of the SBA’s “disjointed approach to ‘good character’ determinations in its various programs,” noting that the approach taken in the proposed rule may be inconsistent with rules and operating policies in other SBA programs that also exclude business owners with a criminal history throuigh “good character” determinations. The comments urge the SBA to abandon entirely the “undefined and potentially invidious ‘good character’” test, and instead to adopt “an evidence-based, transparent, and objective method of assessing the intersection between criminal record and effective contract performance.” Promulgation of clear standards and procedures in a formal rule will serve the interests of both the SBA and applicants for certification, as well as the national interest in reintegration of justice-affected individuals. The comments suggest that the SBA look to recent state reforms in occupational and professional licensing statutes, in which states have rooted out similarly vague statutory terms such as “good moral character” or restrictions applicable to crimes of “moral turpitude.” Instead of using such ill-defined terms, licensing reforms have required assessment of candidates on a case-by-case basis guided by clear standards and processes that examine whether, among other things, a conviction is directly related to the occupation or profession, how much time has passed since the conviction, and evidence of mitigating circumstances and subsequent rehabilitation. CCRC’s work in connection with this comment to the SBA is directly related to its larger “Fair Chance Lending” project, on which it is partnering with the University of Michigan’s Ford School of Public Policy.  There will be more in this space about that project in weeks to come.         Read more