Dealmakers know that uncertainty is their proverbial kryptonite. As M&A and investment have started to show signs of life, acquirers of and investors in companies that received loans under the Paycheck Protection Program (PPP) have been grappling with managing the risks associated with those loans, including whether and what kinds of approvals are necessary to acquire or invest in such a target. Recently, however, the U.S. Small Business Administration (SBA) has acted to reduce this uncertainty by releasing SBA Procedural Notice (5000-20057) (the Notice), which details the procedures that must be complied with before closing a transaction involving a change of ownership of a PPP loan recipient.

As a quick reminder, the CARES Act, as supplemented by the PPP Flexibility Act of 2020, established the PPP as a unique form of loan guaranteed by the SBA under Section 7(a) of the Small Business Act (7(a) loans), the flagship federal loan program for small businesses. In the case of traditional (non-PPP) 7(a) loans, the SBA’s loan servicing guidelines require lenders to obtain the SBA’s consent before approving any adjustment or change in the ownership (with no specified threshold) of a 7(a) loan borrower that occurred within 12 months of the final disbursement of the 7(a) loan.[1] But, in light of the fundamental differences between PPP loans and other 7(a) loans (e.g., the basic purpose of keeping employees on the payroll during the depths of the pandemic and the potential for complete PPP loan forgiveness), it was not clear if the SBA-approval requirement was meant to apply to transactions involving PPP loans. And, as SBA approval can take some time to receive even in normal times, this uncertainty was seen as a significant hurdle to deal-making.  

SBA Approval Requirements

If the contemplated transaction involves a change of ownership[2], then prior to the closing, the PPP borrower must notify the PPP lender or the lender servicing the PPP loan (the PPP lender), as applicable, in writing of the transaction and provide copies of the proposed agreements effectuating the transaction. The requirements and procedures for obtaining the SBA’s approval then depend on the circumstances of the change in ownership as follows:

No SBA Approval – PPP Note is Fully Satisfied

No pre-transaction approval is necessary for a change of ownership if, prior to closing of the transaction, the PPP borrower has either (1) repaid the PPP loan in full or (2) completed the loan forgiveness process, and (i) the SBA has remitted funds to the PPP Lender in full satisfaction of the Note or (ii) the PPP borrower has repaid any balance of the PPP loan that is not forgiven.

No SBA Approval – PPP Note is Not Fully Satisfied

If a change of ownership transaction is structured as a sale of equity or merger, the PPP lender may only approve the transaction without the SBA’s prior approval if either:

1. the sale or other transfer (when aggregate with all other transfers since the PPP loan approval date) involves 50% or less of the common stock or other ownership interests of the PPP borrower; or
2. (i) the PPP borrower submits a completed PPP loan forgiveness application (together with required supporting documentation) reflecting its use of all of the PPP loan proceeds to the PPP Lender and (ii) an interest-bearing escrow account controlled by the PPP Lender is established with funds equal to the outstanding balance[3] of the PPP loan. After the forgiveness process is completed, the escrow funds must be disbursed first to repay any remaining PPP loan balance plus interest.

If a change of ownership transaction is structured as an asset sale, a PPP borrower may sell 50% or more of its assets (measured by fair market value) without the SBA’s prior approval only if:

1. the PPP borrower submits a competed PPP loan forgiveness application (together with required supporting documentation) reflecting its use of all of the PPP loan proceeds to the PPP Lender; and
2. an interest-bearing escrow account controlled by the PPP Lender is established with funds equal to the outstanding balance of the PPP loan (including any accrued interest). After the forgiveness process is completed, the escrow funds must be disbursed first to repay any remaining PPP loan balance plus interest. The PPP Lender must notify the appropriate SBA Loan Servicing Center of the location of, and funds in, the escrow account within five business days of complete.

SBA Approval Required

If a change in ownership does not meet the conditions described above, the PPP Lender cannot unilaterally approve the change of ownership and prior approval from the SBA is required.

To obtain the SBA’s approval, the PPP Lender must submit a request to the appropriate SBA Loan Servicing Center setting forth (1) the reason that the PPP borrower cannot fully repay the PPP Loan or escrow the required funds; (2) the detail of the proposed transaction; (3) a copy of the PPP promissory note; (4) any letter of intent or purchase agreement setting forth the responsibilities of the PPP borrower, seller (if different than the borrower) and buyer; (5) disclosure of whether the buyer has an existing PPP loan (including the SBA loan number, if so); and (6) a list of all owners of 20% or more of the purchasing entity.

The SBA may, in its discretion, condition its approval on the implementation of additional risk mitigation measures. The SBA will review and provide a determination within 60 calendar days of submission of a complete request for approval.

Indirect Transfers

The Notice does leave open the question of whether an indirect change of ownership of a PPP borrower by virtue of transferring interests in the PPP borrower’s owner(s) triggers the SBA prior approval requirements. The Notice does not directly refer to indirect transfers, but its use of the phrase “other ownership interests of a PPP borrower” in the definition of change of ownership arguably can be read as encompassing indirect transfers. Accordingly, further guidance from the SBA on this point is certainly welcome. But in the absence of any such clarifying guidance, particularly in a transaction involving the sale of 50% or more of ownership interests of an indirect owner of the PPP borrower, we recommended that the interested parties seek further clarification from the PPP Lender or the appropriate SBA Loan Servicing Center.

Post-Transaction Obligations

Regardless of any change in ownership, the PPP borrower remains liable for (1) performance of all obligations under the PPP loan; (2) the certifications made in connection with the PPP loan application, including the economic necessity certification; and (3) compliance with all other applicable PPP requirements. Additionally, the PPP borrower is responsible for obtaining, preparing and retaining all required forms and supporting documentation and providing such forms and documentation to the PPP Lender or the SBA upon request. As discussed further below, the parties should ensure that the definitive agreement in a change of ownership transaction reflects the continuing liability of the PPP borrower through the use of appropriately tailored representations and warranties and indemnification provisions.

Similarly, in the event of any transfer of ownership interests in a PPP borrower involving the sale of equity or a merger (whether or not such transfer meets the threshold of a change of ownership transaction requiring SBA approval), the PPP borrower (or the successor to the PPP borrower in the case of a merger into another entity) will remain subject to all obligations under the PPP loan. Additionally:

• if the new owner(s) use PPP funds for unauthorized purposes, the SBA will have recourse directly against the new owner(s) for the unauthorized use;
• if any new owner(s) or the successor has a separate PPP Loan then the new owner(s) (in the case of a sale of equity) or the successor (in the case of a merger) are responsible for segregating and delineating PPP funds and expenses and providing documentation demonstrating compliance by each PPP borrower; and
• within five business days of the closing of the change of ownership transaction, the PPP Lender must notify the appropriate SBA Loan Servicing Center of the (i) identify of the new owner(s) of the equity interest; (ii) new owner(s) ownership percentage(s); (iii) tax ID number for any new owner holding 20% or more of the equity in the business; and (iv) the location of, and amount of funds in, the escrow account (if required).

Finally, the approval of a change of ownership involving a sale of 50% or more of the PPP borrower’s assets will be conditioned on the buyer assuming all of the PPP borrower’s obligations under the PPP loan, including responsibility for compliance with PPP loan terms. The purchase agreement or a separate assumption agreement must specifically acknowledge the assumption of the PPP borrower’s obligations under the PPP loan.

Mitigating PPP-Related Risks

Although the Notice helpfully eliminates the uncertainty over whether prior SBA approval is needed in change of ownership transactions, the requirement obviously may delay the deal timeline if the full amount of the principal and interest cannot be escrowed. And beyond delays in timing, the PPP loans will still carry some amount of risk (for example, that the borrower did not make the economic necessity certification in good faith and therefore was not eligible to receive the loan) that a buyer/investor likely will want to avoid.

Accordingly, buyers/investors would prefer (assuming the parties have contemplated a debt-free acquisition) to simply treat a PPP loan as similar to any other indebtedness and require repayment of the PPP loan at or prior to closing. But, given that this approach deprives the seller or the target, as the case may be, of potential benefits of loan forgiveness, the parties may need to agree to allocate the risk through the use of indemnification and/or PPP loan insurance.

We recommend that the parties consider supplementing purchase agreements with representations and warranties specifically related to the PPP loan including, for example, that the borrower was eligible to participate in the PPP program, that all certifications and information included in the borrower’s loan application were true and made in good faith, that the borrower used the loan proceeds solely for forgivable purposes and complied with other forgiveness requirements and what aid (if any) the borrower received under any other governmental relief programs.

Depending on the negotiating dynamics, the parties may then agree to treat the PPP-related representations as “fundamental” or otherwise subject to an extended survival period and a higher cap on indemnifiable losses. Alternatively, an even stronger pro-buyer approach would include direct, uncapped indemnity coverage for any losses related to the seller’s non-compliance with PPP requirements.

Finally, given difficulty in assessing risks associated with PPP loans as a part of a rapidly-implemented program subject to continually evolving rules and guidance, the parties should consider the use of PPP loan insurance. Due to the uncertainty associated with shifting regulatory guidance, it’s not clear whether any traditional representations and warranties polices will cover PPP loan matters. However, some insurers are now offering policies addressing PPP loans specifically. These policies generally cover the risk that the “economic necessity” certification was not accurate when made and any losses arising out of a borrower’s lack of eligibility to have received the PPP loan. However, they generally do not cover the government’s denial of loan forgiveness. While the terms and conditions of this coverage continue to evolve in the face an uncertain regulatory landscape, these types of policies may be particularly useful when the parties are otherwise unable to find a satisfactory middle-ground approach for allocating risk.

[1] See Procedural Notice 5000-19009; SOP 50 57 2; SOP 50 10 5(k).

[2] As a preliminary matter, the Notice defines a “ change of ownership” as a transaction in which:

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 (including to an affiliate or an existing owner of the entity) whether in one or more transactions;
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.

For purposes of determining whether the relevant thresholds have been met in an asset or equity transfers, all transfers occurring since the date the SBA approved the PPP loan should be aggregated.

[3] Although the Notice does not explicitly say that accrued interest (or that will have accrued by the time the forgiveness determination is rendered) should be included in the escrow amount, we note that parties should consider doing so. Accrued interest from the initial date of disbursement must be repaid with respect to any portion of the PPP loan that is not forgiven.

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