Eligible Passive Company (EPC) Rule Under 13 CFR 120.111

The eligible passive company rule, set out at 13 CFR 120.111, lets an otherwise-passive holding entity take out an SBA-guaranteed loan to buy, lease, improve, or renovate real property or equipment, so long as it leases those assets to a separate operating business that qualifies for SBA financing on its own.¹ The structure is popular with owners who want their commercial real estate held in a separate LLC or trust while the business runs through a different entity. Every condition in the regulation has to be met; miss one and the loan does not qualify.

What the EPC Can Do With the Loan

An EPC may use SBA proceeds to acquire, lease, improve, or renovate real property or equipment that it then leases to one or more Operating Companies for business use.¹ Proceeds can also finance a change of ownership among the EPC’s existing owners, though the 504 program is stricter about that when the EPC holds assets beyond the core real estate. Any legal form works: corporations, LLCs, partnerships, sole proprietors, tenancies in common, and trusts can all sit in the EPC role.

What the EPC cannot do is operate a business of its own. Its sole function is holding assets for the benefit of an eligible Operating Company. The Operating Company generates the revenue, services the debt, and uses the property. If the holding entity starts doing anything commercial beyond managing the leased property, the structure collapses.

Both Entities Must Qualify as Small

Two eligibility conditions come first. Under paragraph (a)(1), the Operating Company must independently qualify as an eligible small business, and the use of proceeds must be an eligible purpose as though the Operating Company were the direct borrower.¹ That means clearing the same industry-specific revenue or employee thresholds under Part 121 that any SBA borrower would face.

Under paragraph (a)(2), both entities must each meet those size standards.¹ Trusts are the one exception on the EPC side: a trust’s eligibility runs through the trustor’s status rather than the trust’s own characteristics. Every other legal form has to clear the size bar independently.

The Lease Between the EPC and the Operating Company

The lease carries the most weight in the regulation, and it’s where applications fail most often. Under paragraph (a)(3), the lease must be in writing and must be subordinate to the SBA’s mortgage, deed of trust, or security interest in the property.¹ The EPC also has to assign all rents from the lease to the lender as collateral, so a default lets the lender collect rent directly.

Rent is capped. Lease payments cannot exceed the amount needed to cover the loan payment to the lender plus the EPC’s direct holding costs such as property taxes, insurance, and maintenance.¹ The EPC cannot extract profit through the lease. Owners used to charging market rent on their commercial property often find this the hardest part of the rule to accept.

Under paragraph (a)(4), the lease term, including any renewal options, must be at least as long as the loan term, and only the Operating Company may hold the renewals.¹ With real estate loans running up to 25 years, that can be a long lease commitment.

Who Has to Sign for the Debt

Paragraph (a)(5) requires the Operating Company to sign on as either a guarantor or a co-borrower.¹ Which one depends on the use of proceeds. If a 7(a) loan includes working capital or the purchase of other assets like inventory or intangibles for the Operating Company’s use, the Operating Company must be a full co-borrower. A guarantee alone is enough only when the loan funds are limited to real property held by the EPC.

Paragraph (a)(6) reaches individual owners. Any person or entity holding at least 20 percent of either the EPC or the Operating Company must personally guarantee the loan.¹ This tracks the general guarantee requirement at 13 CFR 120.160, which applies to all SBA business loans.² Lenders may also require guarantees from smaller owners when credit considerations call for it. Putting the real estate in a separate holding company does not shield the owners from personal liability on the SBA debt.

When the EPC Is a Trust

Trusts get an extra layer of conditions under 120.111(b). Eligibility runs through the trustor, and anyone who has donated assets to the trust is treated as a trustor for this purpose.¹ A trust acting as an EPC can also engage in activities beyond holding property if the trust agreement allows it, which is a departure from the general rule.

The trustee has to certify that the trustee has authority to act, that the trust can borrow funds and pledge assets, and that the language provided from the trust agreement confirming those powers is accurate.¹ The trustee must also warrant that the trust will not be revoked or substantially changed during the loan term without SBA consent, and the trustor must guarantee the loan. A current list of all trustors and donors goes to the SBA and has to be kept updated for the life of the financing.

When any owner of the EPC is itself a trust, SBA Form 1919 requires a separate entity-owner section completed and signed by the trust, with all trustees listed and 100 percent of ownership disclosed. Each trustor then completes a separate individual or entity owner section.³

Leasing to More Than One Operating Company

An EPC can lease to more than one Operating Company.¹ When it does, every condition applies separately to each one. Each Operating Company must qualify as an eligible small business on its own, each must sign on as co-borrower or guarantor, and the lease terms for each must satisfy the rent cap and the term requirement.

The reverse doesn’t work. You cannot stack multiple EPCs into a single SBA loan. One EPC can own several properties and lease them to the same Operating Company or group of Operating Companies, but the holding side stays as one entity. SBA operational guidance also expects the same group of Operating Companies to jointly occupy each property the EPC owns, rather than splitting the properties so different businesses occupy different buildings.

Occupancy Rules Layered on Top

Separate from the EPC rule itself, the SBA imposes general occupancy standards on any loan financing commercial real estate. For existing buildings, the Operating Company must generally occupy at least 51 percent of the usable space. For new construction, the threshold is at least 60 percent at loan approval, with the Operating Company required to eventually occupy 80 percent. These come from SBA standard operating procedures rather than the CFR, but lenders enforce them during underwriting. Any planned sublease has to fit within those limits.

Documentation Lenders Will Ask For

The regulation itself stops at subsections (a) and (b) and does not spell out a document list, but the conditions generate a predictable paper trail:

Entity formation documents for both sides: articles of incorporation, operating agreements, or trust agreements, showing that the EPC exists to hold assets for the Operating Company’s use.
Ownership records identifying everyone with a 20 percent or greater interest in either entity, since each of them signs a personal guarantee.
A written lease meeting the paragraph (a)(3) and (a)(4) requirements, including the rent cap, subordination language, rent assignment, and a term at least as long as the loan.
SBA Form 1919, which requires the applicant to identify whether it is an EPC, a trust, or another entity type, and to disclose the relationship between the borrowing entities.³
Financial statements or tax returns showing that both the EPC (unless it is a trust) and each Operating Company meet the applicable SBA size standards.

Accuracy on these filings carries real weight. False statements on an SBA loan application are a federal crime under 18 U.S.C. 1014.⁴ Put the structure together correctly at the front end and the EPC framework gives owners the separation they want while keeping the SBA guarantee intact.

1
eCFR. 13 CFR 120.111 – What Conditions Must an Eligible Passive Company Satisfy?
2
eCFR. 13 CFR 120.160 – Loan Conditions
3
U.S. Small Business Administration. SBA Form 1919 Borrower Information Form
4
Office of the Law Revision Counsel. 18 USC 1014 – Loan and Credit Applications Generally