How M&A Activity Will Affect an Outstanding PPP LoanOctober 7, 2020
New SBA Rule Affecting PPP Borrowers Engaging in M&A Activity
On October 2, 2020, the U.S. Small Business Administration (SBA) promulgated SBA Procedural Notice 5000-20057 Paycheck Protection Program Loans and Changes of Ownership, that sets forth new guidance requiring Paycheck Protection Program (“PPP”) borrowers to place into escrow with their PPP lender an amount equal to the borrower’s PPP loan in order to avoid obtaining the SBA’s prior consent to a “Change of Ownership” of the borrower. Prior to issuance of this Procedural Notice, there was no SBA guidance with respect to M&A activity involving PPP borrowers, which left buyers, sellers, and lenders to negotiate their own terms with respect to required consents, allocation of risk and escrows (if any). Going forward, all borrowers will need to comply with the new SBA requirements.
“Change of Ownership” Defined
The Procedural Notice states that for purposes of the PPP, a “Change of Ownership” will be considered to have occurred when:
(1) at least 20% of the common stock or other ownership interest of a PPP borrower (including a publicly traded entity) is sold or otherwise transferred, whether in one or more transactions, including to an affiliate or an existing owner of the entity,
(2) the PPP borrower sells or otherwise transfers at least 50% of its assets (measured by fair market value), whether in one or more transactions, or
(3) a PPP borrower is merged with or into another entity.
PPP Borrower Responsibilities and Requirements
The Procedural Notice makes clear that in the event of a Change in Ownership, PPP borrowers remain responsible for:
(1) performance of all obligations under the PPP loan;
(2) the certifications made in connection with the PPP loan application, including the certification of economic necessity; and
(3) compliance with all other applicable PPP requirements.
In addition, if the buyer in a stock sale uses PPP funds for unauthorized purposes, the SBA will have recourse against the buyer for the unauthorized use.
How Does this Affect My M&A Deal?
Prior to the closing of any Change of Ownership transaction, the PPP borrower must notify the PPP lender in writing of the contemplated transaction and provide the PPP lender with a copy of the proposed agreements or other documents that would effectuate the proposed transaction. The PPP lender is required to continue submitting the monthly 1502 reports until the PPP loan is fully satisfied.
If your PPP Note is fully satisfied, there are no restrictions on a change of ownership. For a PPP Note to have been fully satisfied, the PPP borrower must have either (a) repaid the PPP Note in full or (b) completed the loan forgiveness process in accordance with PPP requirements and either (i) the SBA has remitted funds to the PPP lender in full satisfaction of the PPP Note, or (ii) the PPP borrower has repaid any remaining balance on the PPP loan.
In the event that a borrower’s PPP Note has not been fully satisfied prior to closing the Change of Ownership, then the SBA may need to approve your Change of Ownership.
When SBA Approval is NOT Required
(1) Stock Transfers of 50% or Less
Although a change in 20% of the ownership of the PPP borrower constitutes a Change of Ownership, if the aggregate change from the date of approval of the loan by the SBA is 50% or less, the SBA’s prior approval is not required. In instances of stock transfers between 20-50% of ownership, approval by the lender may still be required; however, the PPP lender may approve such a Change of Ownership without the SBA’s prior approval.
The SBA did not indicate factors a PPP lender should consider in deciding whether to approve such a transaction.
(2) Stock Transfers of More than 50%, Assets Sales and Mergers with a Completed Forgiveness Application, and Escrow
The Procedural Notice further provides that SBA pre-approval is not required for transfers of more than 50% of a borrower’s stock, sales of more than 50% of a borrower’s assets, and mergers involving a borrower in the event that (a) the borrower has submitted a forgiveness application to the PPP lender with any required supporting documentation, and (b) an interest-bearing account controlled by the PPP lender is established with funds equal to the outstanding balance of the PPP Loan.
Upon completion of PPP loan forgiveness process (including any appeals), this lender-controlled escrow must be disbursed first to repay any remaining PPP loan balance plus interest.
No additional guidance is provided to the lender or borrower as to what factors the PPP lender should consider when deciding whether to approve the transaction.
For asset transfers utilizing the escrow mechanism described above, the Procedural Notice does not require the PPP Note to be assumed in such asset sale, and the loan can therefore be left behind with the selling entity.
The Procedural Notice also does not specify which party must fund the escrow and how escrowed funds in excess of any funds used to repay the remaining PPP loan balance plus interest are to be disbursed following PPP loan forgiveness. Presumably, these are issues that can be negotiated between the PPP borrower and its buyer.
When SBA Approval IS Required
For instances that constitute a Change of Ownership that do not fall within the exceptions noted above (i.e., less than 50% stock sale or no forgiveness application filed and lender-controlled escrow established), SBA prior approval of the Change of Ownership is required and a PPP lender may not unilaterally approve the Change of Ownership.
To obtain the SBA’s prior approval, the PPP lender is responsible for submitting the following information to the SBA:
(1) the reason that the PPP borrower cannot repay the note in full or establish the escrow;
(2) the details of the requested transaction;
(3) a copy of the executed PPP Note;
(4) any letter of intent and the purchase or sale agreement setting forth the responsibilities of the PPP borrower, seller (if different from the PPP borrower), and buyer;
(5) disclosure of whether the buyer has an existing PPP loan (and if so, the SBA loan number); and
(6) a list of all owners of 20% or more of the purchasing entity.
The SBA Procedural Notice provides that the SBA may also require additional risk mitigation measures as a condition of its approval of any transaction if the SBA deems appropriate. There is no timeframe within which the SBA is required to issue a decision with respect to its approval (or disapproval) of a transaction. Given this, it seems likely that buyers and sellers will elect the escrow mechanism in order to ensure a timely closing (it would also presumably be difficult to provide an explanation acceptable to the SBA as to why an escrow of purchase price proceeds is not possible).
Lastly, the Procedural Notice provides that if the buyer in a transaction structured as a sale of ownership interests or a merger has its own PPP loan, the borrowers must make sure to segregate PPP funds and expenses and provide documentation to separately demonstrate compliance by each borrower with the terms the PPP.
The Hinckley Allen team is here to help answer specific questions and offer advice on your options with respect to PPP loan forgiveness. Please contact any member of our Corporate & Business Group to discuss.