The Small Business Administration recently issued a procedural notice to Paycheck Protection Program lenders addressing the treatment of PPP loans in the context of a “change of ownership” of the borrower and whether prior SBA approval must be obtained in such transactions. This LawFlash provides key takeaways relevant to M&A transactions involving PPP borrowers.
The Small Business Administration (SBA) issued Procedural Notice No. 5000-20057 to all SBA employees and Paycheck Protection Program (PPP) lenders on October 2, 2020. The procedural notice expands on existing lender guidelines, requiring prior SBA approval under certain circumstances, including a “change of ownership” of the borrower, with respect to PPP loans. This important guidance provides more certainty for market participants with respect to a previously ambiguous regime around the treatment of PPP loans in mergers and acquisitions (M&A) and investment transactions. Our firm’s prior interpretive guidance and suggestions on these issues appears to have been largely adopted by SBA in its procedural notice.
For a more comprehensive discussion of considerations for analyzing, structuring, negotiating, and executing M&A and investment transactions involving PPP loans, read our White Paper, Navigating PPP Loans in M&A Transactions.
The PPP loan program was promulgated as part of the SBA’s existing Section 7(a) loan program. The SBA used its preexisting forms and operating procedures for the 7(a) program when establishing PPP loans. SBA loan servicing guidelines for the 7(a) program provide that SBA lenders must obtain the prior approval of the SBA in respect of certain transactions, including (1) any proposed change in the ownership of a borrower in the first 12 months after loan disbursement, and (2) any transfers of at least 90% of a loan and/or a release of the original PPP borrower. PPP lenders were not permitted to unilaterally consent to these transactions. The existing 7(a) guidelines left “change of ownership” undefined, other than to provide that any change of ownership, even a change in the percentage of ownership held by various owners, would trigger the prior SBA approval requirement. PPP loans are unsecured loans. As a result, acquisitions of all or substantially all of a PPP borrower’s business by way of an asset sale in which the loan was excluded from the sale and left behind with the borrower/seller were not expressly subject to the SBA prior approval requirement.
Before the issuance of the October 2 procedural notice, numerous questions arose concerning the application of these SBA approval guidelines to PPP loans in the context of M&A and investment transactions in light of the unique features of the loans—namely, the ability for the loans to be forgiven and the unsecured nature of the loans. These issues had a direct impact on deal parties as they considered structures and timelines for their transactions, as seeking SBA approval could entail significant lead time with very uncertain results.
In the procedural notice, the SBA defines a “change of ownership” for purposes of the PPP to include transactions where (1) at least 20% of the stock or other ownership interests of a PPP borrower are sold or otherwise transferred, whether in one transaction or in multiple transactions that, when aggregated together with other transactions since the loan approval, result in at least 20% of such interests having been sold or transferred; (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. In respect of clause (1) above, for publicly traded borrowers, only transfers that result in a single holder owning at least 20% of the equity interests of the borrower must be aggregated.
One issue that remains unsettled after the issuance of the procedural notice is whether an indirect change of ownership of a PPP borrower triggers the SBA prior approval requirements applicable to 7(a) loans (and, therefore, PPP loans). SBA guidance to date has not addressed this issue. The reference in the procedural notice to “other ownership interests of a PPP borrower” in defining a change of ownership for purposes of the PPP leaves the door open for continued confusion on this issue. In situations involving an indirect change of ownership, especially where the change of ownership involves a sale or other transfer of greater than 50% of the stock or other ownership interests of the indirect owner of the PPP borrower, the PPP lender should consider seeking further clarification from the appropriate SBA Loan Servicing Center.
If a PPP loan were repaid in full or the SBA had already made a forgiveness determination and remitted the forgiveness amount to the PPP lender, no restrictions or approvals in respect of a change of ownership transaction would apply. Outside of this scenario, where the PPP loan is not yet fully satisfied, the procedural notice provides that the applicable procedures will vary in an M&A context.
Prior to the closing of any change-of-ownership transaction, whether or not consent of the SBA would be required, the procedural notice expressly stipulates that the PPP borrower must provide to its PPP lender written notice of the contemplated transaction, together with a copy of the proposed transaction documentation.
Transactions Not Requiring Prior SBA Approval: Aside from the scenarios described above where no consent is required, PPP lenders may unilaterally consent to a transaction without the prior approval of the SBA in the following scenarios:
Transactions Requiring Prior SBA Approval: Changes of ownership other than those described above will require the prior approval of the SBA, leaving the possibility for SBA approval to be obtained even if the escrow mechanics are not feasible for some reason, thereby enabling market participants a greater degree of flexibility to come up with alternative deal structures or solutions to mitigate SBA approval risk. The procedural notice sets forth the following information regarding the materials, conditions, and timing for obtaining an SBA approval:
PPP Borrower Remains on the Hook: The procedural notice provides an important reminder to PPP borrowers that, even following any change of ownership, the PPP borrower remains responsible for, and the SBA may still hold the PPP borrower accountable for, (1) the performance of all obligations under the PPP loan; (2) the certifications made in connection with the PPP loan application; (3) compliance with all other applicable PPP requirements; and (4) obtaining, preparing, and retaining all required PPP forms and supporting documentation and providing those forms and supporting documentation to the PPP lender or to SBA upon request. In addition, if the new owner(s) following the change of ownership use PPP funds for unauthorized purposes, the SBA will have recourse against the owner(s) for such unauthorized use.
Existing Buyer PPP Loans: If the buyer in a change-of-ownership transaction already has a separate PPP loan in place, following consummation of the transaction, (1) in the case of a stock or equity transaction, the PPP borrower and the new owner(s) must segregate and delineate PPP funds and expenses and provide documentation to demonstrate compliance with PPP requirements by each PPP borrower, and (2) in the case of a merger, the successor must segregate and delineate PPP funds and expenses and provide documentation to demonstrate compliance with PPP requirements with respect to both PPP loans.
Lender Notice Requirements: Within five business days of any change of ownership, the PPP lender must provide notice to the appropriate SBA Loan Servicing Center of the following: (1) the identity of the new owner(s); (2) the percentage ownership of the new owner(s); (3) the tax identification number for any owner(s) holding 20% or more of the equity in the business; and (4) if applicable, the location of, and the amount of funds in, any escrow account under the control of the PPP lender.
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If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Orange County/Los Angeles
Steven L. Miller