SBA Provides Guidance on Changes of Ownership of PPP Borrowers

Bryan Cave Leighton Paisner
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On October 2, 2020, the SBA Office of Capital Access published Procedural Notice 5000-20057, which provides a framework to address whether SBA pre-approval is required for various changes of ownership under the Paycheck Protection Program, as well as the process for seeking that approval if needed. Any Paycheck Protection Program borrower looking at a potential change in control, whether via actions of the shareholders or direct action by the PPP borrower needs to be familiar with this guidance. In addition, anyone looking to acquire control of a PPP borrower should also review the guidance. While the guidance makes clear the possibility of preserving the potential for forgiveness of the PPP loan through a change of ownership, the Procedural Notice sets forth various approaches to obtain SBA pre-approval for the transaction (or to avoid the need for SBA pre-approval.)

Before outlining the key elements of the SBA guidance, we must note that this guidance is being published almost six months after the first PPP loans were issued, and two months after the SBA advised that guidance on changes of ownership would be issued “soon.” While one might hope that such delay at least allowed for clear and complete guidance to be published, I’m afraid the guidance may result in more questions than answers.

General Rule

Without expressing a basis for such obligation, SBA Procedural Notice provides that 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.”

While only specifically requiring notification (as opposed to application or consent), this requirement would seem inconsistent with the SBA’s Frequently Asked Questions and Interim Final Rule permitting lenders to use their own promissory note and to include any terms not inconsistent with Sections 1102 and 1106 of the Cares Act, the PPP Interim Final Rules and Guidance, and SBA Form 2484. While the SBA general form of promissory note does require lender’s prior consent if a borrower “reorganizes, merges, consolidates, or otherwise changes ownership or business structure,” these terms were not defined and lender’s were expressly permitted to use other forms of note.

Changes of Ownership Defined

For purposes of the SBA Procedural Notice, “Changes of Ownership” are defined to consist of the following transactions:

  • an aggregate change in 20% or more of the ownership interests in the Borrower since date of SBA approval of the SBA loan (but for public companies, only need to include sales or transfers resulting in one person owning at least 20%) (stock transfers);
  • sale or transfers of 50% or more of the fair market value of the assets of the Borrower (asset sales); and
  • mergers with or into another entity (mergers).

As discussed above, if any of these events are scheduled to occur prior the PPP loan being forgiven and/or paid off, then the Procedural Notice calls for the Borrower to notify the Lender. In addition to any approvals required by the Procedural Notice (and even if no approval is necessary), the Lender must notify the appropriate SBA Loan Servicing Center within 5 business days after completion of the Change of Ownership of:

  • the identify of the new owner(s);
  • new ownership percentages; and
  • tax identification number(s) of any owner(s) holding 20% or more of the borrower.

No Restrictions if PPP Loan is 100% Forgiven or Paid Off

The SBA Procedural Notice confirms that there are no restrictions on Changes of Ownership in the event that prior to the Change of Ownership, the PPP Note is repaid in full, whether due to borrower repayment or forgiveness by the SBA (or a combination of both).

Stock Transfers of 50% or Less

While changes in more than 20% of the ownership of the PPP borrower constitute a Change of Ownership, so long as 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 for changes. Approval by the Lender for such transactions may still be required, as the SBA Procedural Notice provides that the PPP Lender “may approve the change of ownership” without the SBA’s prior approval. No additional details are provided to the Lender or Borrower as to what factors would reasonably go into the Lender’s decision in such a circumstance. However, as reflected in the SBA approval process discussed below, such approval appears tied to a risk assessment of the chances for repayment of the PPP loan rather than any absolute prohibition or conditions on the nature of the proposed acquirer of control of the borrower.

Stock Transfers of More than 50%, Asset Sales and Mergers with a Completed Forgiveness Application and an Escrow of Funds

The SBA Procedural Notice provides a narrow exception for needing SBA pre-approval for stock transfers of more than 50% control, asset sales, and mergers with two conditions that have to be satisfied.

First, the borrower must have submitted a forgiveness application to the PPP Lender, together with any required supporting documentation. The SBA Procedural Notice further provides that such application must reflect the borrower’s use of all of the PPP loan proceeds, although it isn’t clear why a partial submission shouldn’t be satisfactory (with the understanding that only one forgiveness application may be submitted by any PPP borrower).

Second, an interest-bearing account controlled by the PPP Lender must be established with funds equal to the outstanding balance of the PPP Loan. After the forgiveness process is complete (including any appeals), the fust must be disbursed first to repay any remaining PPP loan balance plus interest. Presumably, such interest-bearing account is contemplated to pay a 1% interest rate to offset the interest accruing on the PPP loan, and the outstanding balance should reflect interest accrued up to the date that the interest-bearing account is funded, although these facts are not specified in the SBA Procedural Notice. One would also hope that a non-interest bearing account funded with 102% of the principal balance of the PPP notice (or 105% for those PPP Notes with a five year maturity) should provide sufficient protection to the SBA and Lender.

As with Stock Transfers of 50% or less, approval of the Change of Ownership by the PPP Lender would appear to still be required. No additional details are provided to the Lender or Borrower as to what factors would reasonably go into the Lender’s decision in such a circumstance. However, as reflected in the SBA approval process discussed below, such approval appears tied to a risk assessment of the chances for repayment of the PPP loan rather than any absolute prohibition or conditions on the nature of the proposed acquirer of control of the borrower.

For asset transfers with the contemplated escrow, unlike where SBA pre-approval is needed as discussed below, the Procedural Notice does not require the PPP note to be assumed in such asset sale. The Procedural Notice also does not specify which party must funds the escrow and/or who shall receive the escrow funds following PPP loan forgiveness. This approach appears consistent with common industry practice of a desire to leave debt obligations with the seller in an asset sale transaction, and potentially allows the structuring of a transaction where the risks and benefits of forgiveness are left with the seller.

SBA Approval Process for Other Changes of Ownership

For Changes of Ownership where the conditions discussed above are not satisfied, the SBA Procedural Notice provides that SBA prior approval of the Change of Ownership is required and the 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 (and presumably Lenders will require this information from Borrowers):

  • the reason that the PPP borrower cannot repay the note in full or establish the escrow contemplated above;
  • the details of the requested transaction;
  • a copy of the executed PPP note;
  • any letter of intent and/or the purchase or sale agreement setting for the responsibilities of the borrower, seller and buyer;
  • disclosure of whether the buyer has an existing PPP loan (and if so, the SBA loan number); and
  • 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.

The Procedural Notice also makes clear that asset sales requiring SBA pre-approval will only be approved if the the purchasing entity assumes the PPP note and all of the Borrower’s obligations under the note, including compliance with the note terms. Assumption of the PPP note is not a condition to utilizing the escrow exception discussed above; as long as an escrow is used, the Procedural Notice appears to be indifferent as to whether the PPP note is assumed in an asset sale, who funds the escrow and/or who receives the escrow funds following PPP loan forgiveness.

Continuity of PPP Obligations

The SBA Procedural Notice makes clear the SBA’s expectation that in the event of a stock transfer or merger, the PPP Borrower (and successor) remains subject to all obligations under the PPP loan and that if the new owner(s) use the PPP funds for unauthorized purposes, the SBA will have recourse against the owner(s) for such unauthorized use.

If, as a result of a Change of Ownership, a new owner or successor has multiple PPP loans, the Procedural Notice explains that the borrower remains responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with respect to all such PPP loans.

Regardless of any Change of Ownership, the PPP Borrower remains responsible for:

  • all PPP loan obligations;
  • any certifications made in connection with the PPP loan application;
  • all other applicable PPP requirements; and
  • obtaining, preparing, and retaining all required PPP forms and supporting documentation and providing to the lender or SBA upon request.

If a PPP loan was pledged by the PPP lender to the Federal Reserve’s PPPLF facility, the lender is reminded of obligations to comply with any notification or other requirements of the PPPLF.

Questions Remaining

  1. What if the PPP Lender doesn’t have the right to approve (or even receive notice of) a Change in Ownership under the terms of their Note?
  2. What standards are PPP Lenders intended to apply with regard to Change in Ownership requests?
  3. What are the ramifications of failing to comply with the Procedural Notice? Does the Lender face a loss of the SBA Guarantee? Does the Borrower risk loss of eligibility for forgiveness of the PPP loan?
  4. Does the Procedural Notice apply to Changes in Ownership that occured prior to October 2, 2020? What if the Lender approved a Change in Ownership prior to October 2, 2020? If a Change in Ownership has already occurred, what should a PPP Borrower do? What should a PPP Lender do?
  5. Can a Borrower use the escrow approach even if they haven’t yet used all of the PPP loan proceeds but has gone ahead and submitted a forgiveness application based on the funds that have been used?
  6. If an application is required, what are the acceptable reasons for the Borrower not paying off the PPP note? Is a desire to seek forgiveness sufficient?
  7. If an application is required, what are the acceptable reasons for not establishing an escrow? If the Borrower has not yet filed its forgiveness application, is that a sufficient reason for not establishing an escrow?
  8. Are PPP Lenders obligated to offer an escrow arrangement?
  9. Does the interest-bearing account need to bear a minimum level of interest? Can a Borrower provide protection to a Lender by placing more funds in the escrow account to offset a lower interest rate? In the language of the Procedural Notice, does “outstanding balance of the PPP loan” include interest but the “remaining PPP loan balance” does not include interest; and if not, why does the Procedural Notice specify that the escrowed funds must first repay the “remaining PPP loan balance plus interest?”

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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