The United States Department of the Treasury (Treasury) and the Small Business Administration (SBA) both continue to issue information and guidance with respect to the Paycheck Protection Program (PPP) and the loans made available under it by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). On October 2, 2020, the SBA issued Procedural Notice No. 5000-20057, to all SBA employees and lenders participating in the PPP. The new guidance is of particular importance to PPP borrowers contemplating a merger or other form of sale while their PPP loan is outstanding.

Background

The PPP loan program is administered as part of the SBA’s Section 7(a) loan program, the SBA’s primary program for providing financial assistance to small businesses, and PPP loans are generally subject to the same regulatory guidelines that apply to all 7(a) loans. One such requirement is that lenders participating in a 7(a) loan program must seek the SBA’s prior consent before a lender can approve a change of ownership of the borrower that occurs within 12 months of the loan’s disbursement. The existing guidelines for the 7(a) loan program, however, did not define “change of ownership” and until now it has not been clear if the SBA’s consent rights applied to transactions involving the sale of the PPP borrower’s assets or sales of less than a controlling interest in the PPP borrower. While M&A transactions are traditionally structured as debt-free transactions where all existing indebtedness of the target company is repaid in full at closing, target companies are often hesitant to repay PPP loans in connection with a M&A transaction because of the possibility such loans may ultimately be partially or entirely forgiven by the SBA. However, a failure to secure consent from the SBA prior to closing such a transaction could ultimately result in the SBA denying an application forforgiveness regardless of the borrower’s eligibility, raising questions for how borrowers should handle their PPP loans in the context of a M&A transaction. It was also unclear under the existing 7(a) guidelines how the SBA would approach transactions in which both the target and the acquiror had PPP loans.

Note that this client alert only addresses requirements for seeking SBA approval of transactions involving a change of ownership of PPP Borrowers. Additional approvals or waivers may be required under the terms of the loan documents governing the PPP loan. PPP borrowers should carefully review the terms of their loan documents to understand what additional requirements they may need to satisfy prior to consummating a change of ownership transaction.

Updated Guidance

The updated guidance from the SBA provides some much needed clarifications for borrowers under the PPP which are summarized below.

Definition of Change of Ownership

The guidelines provide a definition of “change of ownership” for purposes of the PPP, deeming such an event 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. Under this updated guidance it is now clear that transactions involving the sale of substantially all of a PPP borrower’s assets or sales of more than 20% of the equity interest in a PPP borrower will constitute a change of ownership under the 7(a) rules.

SBA Approval Exceptions

The new guidance also provides PPP borrowers and lenders a framework for determining when approval from the SBA is required for transactions involving a change of ownership of a PPP borrower. Notably, if the PPP loan has already been paid in full or if the SBA has already made a determination of forgiveness and remitted the forgiveness amount to the PPP lender, no consent from the SBA will be required for the transaction. If the PPP loan has not otherwise been satisfied in full,

In a stock sale or merger, if either:

• less than 50% of the stock or other ownership interests of the PPP borrower (calculated on an aggregate basis with other transactions since the PPP loan was originally approved) is sold or transferred; or

• the PPP borrower completes and submits a loan forgiveness application reflecting its use of all PPP loan proceeds to the PPP lender and puts into an interest-bearing escrow account controlled by the PPP lender an amount equal to the outstanding balance of the PPP loan.

• In a sale of 50% or more of the PPP borrower’s assets, if the PPP borrower completes and submits a loan forgiveness application reflecting its use of all PPP loan proceeds to the PPP lender and puts into an interest-bearing escrow account controlled by the PPP lender an amount equal to the outstanding balance of the PPP loan.

The consent of the SBA is required for all other transactions involving a change of ownership of a PPP borrower and the PPP lender may not unilaterally approve the transaction.

SBA Approval Submission

In order to obtain the SBA’s approval for a change of ownership, the PPP lender must submit the following documents to the SBA Loan Servicing Center:

• the reason that the PPP borrower cannot fully satisfy the PPP Note or escrow the funds;

• the details of the requested transaction;

• a copy of the executed PPP Note;

• 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;

• 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 may require additional risk mitigation measures as a condition of its approval of the transaction. Further, the SBA has noted that a condition to its approval of any change of ownership transactions structured as an asset sale is that the purchasing entity, either expressly in the definitive purchase agreement or in a separate assumption agreement to be submitted to the SBA, assume all of the PPP borrower’s obligations under the PPP loan, including responsibility for compliance with the PPP loan terms. The SBA will review requests for consent and make its determination within 60 days of its receipt of all required materials.

Ongoing Responsibilities of PPP Borrowers

Of note, regardless of any change of ownership, the SBA has also noted in its guidance that the PPP borrower will remain responsible for (1) the 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. The SBA reserves all rights and remedies available to it under the law in the event of fraud, false statements and/or unauthorized use of PPP loan proceeds. 

Multiple PPP Loans

The updated SBA guidance also addresses the scenario in which both the target in a change of ownership transaction and the new owners or successors in the transaction have separate PPP loans. In this situation, following the consummation of the transaction:

• in the case of a purchase or other transfer of common stock or other ownership interest, the PPP borrower and the new owner(s) are responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements by each PPP borrower; and

• in the case of a merger, the successor is responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with PPP requirements with respect to both PPP loans.

If you are contemplating a M&A transaction in which both the purchasing entity and the target have PPP loans, it is important that you adhere to these strict segregation rules for the PPP loans following the closing for purposes of preserving the PPP borrowers’ ability to seek loan forgiveness.

Unanswered Questions

While the new guidelines from the SBA have provided some much needed guidance for PPP borrowers with pending M&A transactions, a number of open questions remain about the loan forgiveness process:

• How do these rules apply to change of ownership transactions that closed before the new guidance was issued?

• What are the consequences of failure to obtain SBA consent, either prior to or after issuance of the new guidelines?

• Are there potential successor liability or fraudulent transfer risks for the acquiror or successor in a change of ownership transaction if SBA consent is required but not obtained?

• How do PPP borrowers navigate the circumstances where PPP lenders have not yet opened application portals for seeking loan forgiveness?

  We will continue to monitor guidance from the SBA over the coming weeks to see if these questions are ultimately answered. In the meantime, for our clients that have recently closed M&A transactions where the target company was the borrower under a PPP loan and did not receive prior consent from the SBA for the transaction, we suggest considering the following initial steps pending further instructions from the SBA:

• Have the PPP borrower work with its lender to submit an application for loan forgiveness as soon as reasonably possible

• If the transaction involved the establishment of an escrow fund with a third party escrow agent as security for repayment of the PPP loan, move the escrow funds over to an interest-bearing escrow account with the PPP lender.

•  If the transaction did not involve the establishment of an escrow fund as security for repayment of the PPP loan, have the PPP borrower establish an interest-bearing escrow account with its PPP lender in the amount of the outstanding balance of the PPP loan.