The only certainty, so far in 2020, has been uncertainty. For dealmakers and their advisors this is not a helpful observation when they are attempting to close on transactions, often in spite of 2020’s vicissitudes. The Small Business Administration’s (SBA) Paycheck Protection Program (PPP) is one example of a potential hazard in the shape of a gift. These PPP loans were vital lifelines for many borrowers at the height of the COVID-19 pandemic earlier this year, and the SBA reports that over 5 million PPP loans were extended. As appetite to move forward with mergers and acquisitions grows, PPP borrowers and their potential acquirers, along with their respective advisors, have fretted over whether the SBA must consent to a transaction that would result in a change of ownership of a PPP borrower, a common event of default in many, if not most, PPP loans.
Thankfully, the SBA has released much-needed guidance setting out when PPP borrowers can proceed with a change of ownership (i) without either their PPP lender or the SBA’s consent, (ii) with only their PPP lender’s consent, or (iiii) with the SBA’s consent. This Alert summarizes when consent is required for transactions in which a change of ownership of a PPP borrower occurs and whose consent is then needed. As a threshold matter, the SBA has determined that a “change of ownership” occurs with respect to a PPP borrower when (i) at least 20% of the equity in the PPP borrower (including a publicly-traded entity)1 is transferred, whether in one transaction or pursuant to multiple transactions since the date the PPP loan was approved and taking into account transfers to affiliates or an existing owner of the PPP borrower; (ii) at least 50% of the PPP borrower’s assets (measured by fair market value) are transferred, whether in one transaction or pursuant to multiple transactions since the date the PPP loan was approved; or (iii) the PPP borrower is merged with or into another entity. If a deal does not result in a change of ownership as
1 The SBA did clarify that only transfers resulting in one person holding 20% or more of the equity of a publicly-traded PPP borrower must be aggregated to determine if 20% or more of the equity has been transferred.
contemplated in the guidance then, barring any conflicting or additional requirements set forth in the PPP borrower’s loan documentation, the SBA notice does not require any consent.
In the event a PPP borrower is contemplating a change of ownership, it must notify its PPP lender in writing of the contemplated transaction and provide the lender with any deal documentation. However, depending upon the status of the PPP loan and the details of the contemplated transaction, the particular rules applicable to the PPP borrower will differ. In any event, the PPP lender is required to notify the SBA within five business days of a closing of a transaction resulting in a change of ownership of a PPP borrower.
If the PPP borrower’s PPP loan is satisfied in full, then no approval is required.
The SBA has provided that no restrictions apply to the change of ownership of a PPP borrower so long as, prior to the closing of the contemplated transaction, that borrower has:
- repaid the PPP loan in full or
- completed the loan forgiveness process and either (A) the SBA has remitted the funds to the lender in full satisfaction of the PPP loan or (B) the borrower has repaid the remaining balance on the PPP loan.
Simply put, if all PPP loan amounts have either been forgiven or repaid, then the PPP borrower should be able to proceed with a change of ownership without either the PPP lender’s or the SBA’s approval. Full forgiveness and/or repayment is therefore ideal, but understandably, parties may not wish (or it may be impossible) to delay closing on a transaction for the timeframe it takes for this to occur.
A PPP lender alone can approve a change of ownership in certain equity deals or if an escrow account is established to repay the PPP loan.
If the contemplated transaction resulting in a change of ownership is structured as an equity transfer or a merger, the PPP borrower can proceed to closing without the SBA’s approval if the transaction results in the transfer of 50% or less of the ownership interests in the PPP borrower. Presumably, the PPP lender will need sufficient documentation to confirm details of the transaction.
For any other contemplated transaction causing a change of ownership of a PPP borrower—whether by equity transfer, merger or asset sale—the transaction may proceed without SBA approval only if:
- The PPP borrower has used 100% of the PPP loan proceeds;
- The PPP borrower completes and submits to its lender the PPP loan forgiveness application, along with all required documentation;
- An interest-bearing escrow account controlled by the PPP lender is established, into which an amount equal to the outstanding balance of the PPP loan is deposited; and
- Upon completion of the forgiveness process (inclusive of any administrative appeals), escrow funds must first be disbursed to repay the remaining PPP loan balance, plus interest.
The SBA guidance does not mandate that the PPP borrower provide the funds for the escrow account. Presumably, parties to a transaction that would result in a change of ownership in a PPP borrower can allocate the burden of funding the account as required to reach closing. This escrow account path will also undoubtedly be helpful to parties and their advisors in the initial phases of proposing deal terms and drafting documentation.
The Last Resort: SBA Approval
SBA approval is required only if it is impossible to fully pay down the PPP loan ahead of closing or to either (i) structure the transaction as a transfer of 50% or less of the ownership interests in the PPP borrower or (ii) comply with the escrow account procedure described above. Parties falling into this category will still need to work with the PPP lender, which will submit the approval request to the SBA.
The request for SBA approval of a change of ownership must include:
- The justification(s) for why the PPP borrower cannot fully pay down the PPP loan or establish an escrow account;
- A description of the contemplated transaction, along with any letter of intent or other deal documentation setting forth the responsibilities of the PPP borrower;
- A copy of the PPP loan note;
- Disclose whether the buyer has an existing PPP loan and, if so, provide the SBA loan number; and
- A list of all owners holding a 20% or greater interest in the buyer.
The SBA should provide a determination within 60 days of its receipt of a completed request. Note that the SBA guidance clearly contemplates that the SBA can condition its approval on “risk mitigation measures” designed to ensure that the PPP loan balance will be repaid. For instance, the SBA notice provides that, when required, SBA approval of an asset deal resulting in a change of ownership will be conditioned upon the buyer assuming the PPP borrower’s obligations under the PPP loan, and the deal documentation must include language regarding this assumption (unless a separate assumption agreement is submitted to the SBA).
Buyers or successors should take care to keep their own PPP funds separate.
Buyers of (or successor entities to) target-PPP borrowers should take care to segregate their own PPP funds, if any, from those of the target-PPP borrower. Documentation should be maintained to show compliance with PPP requirements for each PPP loan. This guidance is also useful in suggesting that a PPP borrower-purchaser should not be deterred from purchasing a PPP borrower-target, so long as the purchaser and target take care to comply with the PPP rules for each PPP loan.
A transaction does not wipe out liability for a PPP loan.
Any M&A practitioner should be unsurprised by this statement. Nonetheless, for the avoidance of doubt, the SBA provides that a PPP borrower (or, in the case of a merger, its successor) remains subject to its PPP loan obligations. The SBA notice does go further to make it clear that the SBA may go after the new owner(s) of a PPP borrower if those owner(s) use PPP loan funds for unauthorized purposes.
Regardless, M&A transactions are typically a dance of allocating burdens and risks. The year 2020, in all its variety, hasn’t changed that. Surely, armed with this guidance in hand, parties and their advisors can bring these transactions to a close on terms agreeable to buyers and sellers alike.
If you are a PPP borrower looking at your strategic options or a potential purchaser interested in acquiring a PPP borrower, this guidance is a useful tool to keep in mind as you consider how to craft the transaction. This is particularly true with regard to engaging in early discussions on how to structure the escrow account approach upon terms that will enable you and your counterparty to reach a smooth closing. If you have already documented your deal, consider how this guidance may be of use to smooth out any existing issues you have experienced, including through an amendment to deal documentation to make use of the escrow account approach.