SBA Issues New Procedures and Requirements for M&A Transactions Involving PPP Loans

On October 2, 2020, the Small Business Administration (SBA) issued SBA Procedural Notice 5000-20057 (the “Notice”), which introduces rules and guidance for borrowers and lenders under the Paycheck Protection Program (“PPP”) relating to changes in ownership of PPP borrowers. For all of our prior alerts on the PPP, click here.

As PPP borrowers are reaching the end of their Covered Periods, some borrowers are exploring M&A transactions and the potential impact of their PPP loans on such transactions. The inclusion of a PPP loan in an M&A transaction necessitates additional diligence and tailored discussions between the parties to ensure the transaction is appropriately structured and can close when desired by the parties. The Notice is SBA’s first guidance that explicitly addresses changes in ownership of PPP borrowers. The Notice should be carefully reviewed by PPP borrowers that are looking to engage in an M&A transaction, by persons or entities considering acquiring a business, by PPP lenders that may be asked to consent to a change of ownership transaction, and by potential financing sources for acquisitions. We summarize the key provisions and requirements of the Notice below after first providing some background on the terms of PPP loans and the SBA policies that require lender and SBA consent to certain M&A transactions.

Lender and SBA Consent to Changes of Ownership of PPP Borrowers

Lender Consent

PPP loan documents customarily require the consent of the PPP lender to any change of ownership transaction. The SBA form of PPP loan promissory note prohibits any change in ownership and certain other changes in a PPP borrower’s business without the PPP lender’s consent. The form promissory note provides that a borrower will be in default under the note if it “[h]as any adverse change in financial condition or business operation that Lender believes may materially affect Borrower’s ability to pay this Note” or “[r]eorganizes, merges, consolidates, or otherwise changes ownership or business structure without Lender’s prior written consent.”

SBA Consent

SBA previously confirmed that “PPP Lenders are responsible for servicing PPP loans in accordance with SBA SOP 50 57, as amended.” SOP 50 57 requires PPP lenders to obtain SBA’s prior consent to any change of ownership of the borrower within the first 12 months after the final disbursement of the PPP loan. While the Notice provides that SBA approval is required for some, but not all, changes of ownership, SBA confirmed in the Notice that SBA considers some asset sales to be changes of ownership. As a result, SBA consent will be required for certain changes of ownership, whether structured as a sale of ownership interests or assets or as a merger, occurring within the first 12 months after the final disbursement of the PPP loan.

What is a “Change in Ownership” for PPP Purposes?

The Notice explains that SBA, for purposes of the PPP, considers a “change of ownership” to have occurred when one of the following events occurs:

1. at least 20% of the common stock or other ownership interest of a PPP borrower is sold or otherwise transferred, whether in one or more transactions, including to an affiliate or an existing owner of the entity;
2. a 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 merges with or into another entity.

With respect to sales or other transfers of common stock or other ownership interests, the Notice states that for purposes of determining whether the sale or other transfer exceeds the 20% threshold set forth above, “all sales and other transfers occurring since the date of approval of the PPP loan must be aggregated to determine whether their relevant threshold has been met.” For publicly traded PPP borrowers, only sales or other transfers that result in one person or entity holding or owning at least 20% of the common stock or other ownership interest of the borrower must be aggregated.

With respect to asset sales, the Notice states that for purposes of determining whether a sale or other transfer of assets exceeds the 50% threshold set forth above, all sales and other transfers of assets occurring since the date of approval of the PPP loan must be aggregated.

To summarize, each of the following transactions would be considered a “change of ownership” for purposes of the PPP (referred to herein as a “Covered Change of Ownership”):

• a sale or transfer of any common stock or other ownership interests of a privately-owned PPP borrower, if, after giving effect to such sale or transfer, at least 20% of the common stock or other ownership interests in such PPP borrower has been sold or transferred since the date of approval of the PPP loan (referred to herein as a “Covered Private Company Equity Sale”);
• a sale or transfer of any common stock or other ownership interests of a publicly-traded PPP borrower, if, after giving effect to such sale or transfer, at least 20% of the ownership interest in such PPP borrower is owned by one person or entity (referred to herein as a “Covered Publicly-Traded Equity Sale”; Covered Publicly-Traded Equity Sales and Covered Private Company Equity Sales are each referred to herein as a “Covered Equity Sale”);
• a sale or transfer of any assets (measured by fair market value) of a PPP borrower, if, after giving effect to such sale or transfer, at least 50% of the assets of such PPP borrower have been sold or transferred since the date of approval of the PPP loan (referred to herein as a “Covered Asset Sale”); and
• a merger of any PPP borrower with or into another entity (referred to herein as a “Covered Merger”).

Pre-Closing Requirements for Covered Changes of Ownership

The Notice requires a PPP borrower to provide to its PPP lender written notice of a contemplated Covered Change of Ownership before the closing thereof, together with copies of the proposed agreements or other documents that would effectuate the Covered Change of Ownership. The Notice provides different procedures that must be followed depending on the circumstances of the contemplated Covered Change of Ownership and whether the PPP loan has been fully satisfied.

SBA Prior Approval Not Required if PPP Loan is Fully Satisfied

A PPP lender is not required to obtain SBA approval for, and SBA does not impose restrictions on, a Covered Change of Ownership if, before the closing thereof, the PPP borrower has either:

1. repaid the PPP loan in full; or
2. completed the loan forgiveness process in accordance with the PPP requirements, and either:
   1. SBA has remitted funds to the PPP lender in full satisfaction of the PPP loan; or
   2. the PPP borrower has repaid any remaining balance on the PPP loan.

SBA Prior Approval May be Required if PPP Loan is Outstanding

If a PPP loan is to remain outstanding after the closing of a contemplated Covered Change of Ownership transaction, the PPP lender must obtain SBA’s prior approval of the Covered Change of Ownership unless one of the exceptions described below applies.

Covered Equity Sales and Covered Mergers

An owner of a PPP borrower may enter into a Covered Equity Sale or Covered Merger with respect to that PPP borrower without the prior approval of SBA only if:

1. The Covered Equity Sale or Covered Merger involves the sale or other transfer of 50% or less of the common stock or other ownership interest of the PPP borrower, provided that, after giving effect to such sale or transfer, less than 50% of the common stock or other ownership interest in such borrower have been sold or transferred since the date of approval of the PPP loan; or
2. “The PPP borrower completes a forgiveness application reflecting its use of all of the PPP loan proceeds and submits it, together with any required supporting documentation, to the PPP Lender, and an interest-bearing escrow account controlled by the PPP Lender is established with funds equal to the outstanding balance of the PPP loan. After the forgiveness process (including any appeal of SBA’s decision) is completed, the escrow funds must be disbursed first to repay any remaining PPP loan balance plus interest.”

The PPP lender cannot approve any Covered Equity Sale or Covered Merger that does not meet at least one of the requirements above without SBA’s consent.

Based on the foregoing, it would appear that a Covered Equity Sale of between at least 20% but less than 50% of a PPP borrower would require notice to the PPP lender under the Notice, and presumably consent from the PPP lender under the terms of the PPP loan documents, but not SBA consent.

Covered Asset Sale

A PPP borrower may engage in a Covered Asset Sale without the prior approval of SBA only if:

1. “the PPP borrower completes a forgiveness application reflecting its use of all of all of the PPP loan proceeds and submits it, together with any required supporting documentation, to the PPP Lender;” and
2. the borrower establishes an interest-bearing escrow account controlled by the PPP lender with funds equal to the outstanding balance of the PPP loan.

After the forgiveness process, including any appeal of SBA’s decision, is completed, the escrow funds must be disbursed to repay any remaining PPP loan balance, plus interest.

The PPP lender cannot approve any Covered Asset Sale that does not meet the requirements above without SBA’s consent.

Process for Obtaining SBA Prior Approval

If SBA’s prior approval to a contemplated Covered Change of Ownership is required under the Notice, the PPP lender, the PPP borrower, and, depending on transaction structure, the buyer(s) in the Covered Change of Ownership Transaction must take certain actions.

PPP Lender Notification to SBA and Request for Approval

It is the PPP lender’s responsibility to obtain SBA’s prior approval of a Covered Change of Ownership when required under the Notice. The Notice requires the PPP lender submit to the appropriate SBA Loan Servicing Center a request for approval that includes the following:

1. the reason that the PPP borrower cannot fully satisfy the PPP loan or escrow funds as described in the Notice;
2. the details of the requested transaction;
3. a copy of the executed PPP promissory note;
4. any letter of intent and the purchase or sale agreement for the Covered Change of Ownership transaction setting forth the responsibilities of the PPP borrower, the seller (if different from the PPP borrower), and the buyer;
5. whether the buyer has an existing PPP loan and, if so, the SBA loan number; and
6. a list of all owners of 20% or more of the buyer.

“Additional Risk Mitigation Measures”

According to the Notice, “[i]f deemed appropriate, SBA may require additional risk mitigation measures as a condition of its approval of the transaction.” However, the Notice does not indicate what “additional risk mitigation measures” could be required.

Additional Requirements for Asset Sales

SBA approval of any Covered Asset Sale will be conditioned on the buyer assuming all of the PPP borrower’s obligations under the PPP loan, including responsibility for compliance with the PPP loan terms. The Notice requires the asset purchase agreement or other definitive agreement for the Covered Asset Sale “include appropriate language regarding the assumption of the PPP borrower’s obligations under the PPP loan by the purchasing person or entity, or a separate assumption agreement must be submitted to SBA.”

Timing of SBA Review

According to the Notice, SBA will review and provide a determination within 60 calendar days of SBA’s receipt of the PPP lender’s request for approval. Because any required PPP lender consent to a Covered Change of Ownership transaction will not be granted until SBA provides its approval, buyers and sellers considering entering into a Covered Change of Ownership transaction will need to factor this into their anticipated closing timelines and plan accordingly. If the parties to a contemplated Covered Change of Ownership transaction do not want to wait for SBA approval when required under the Notice (nor, presumably, the PPP loan forgiveness process to be completed), the PPP borrower may have no choice but to repay the PPP loan in full before closing.

Additional Requirements for Covered Equity Sales and Covered Mergers (Regardless of Whether SBA Approval is Required)

Under the Notice, “[i]n the event of a sale or other transfer of common stock or other ownership interest in the PPP borrower, or a merger of the PPP borrower with or into another entity, the PPP borrower (and, in the event of a merger of the PPP borrower into another entity, the successor to the PPP borrower) will remain subject to all obligations under the PPP loan.” The Notice warns that “if the new owner(s) use PPP funds for unauthorized purposes, SBA will have recourse against the owner(s) for the unauthorized use.”

If any new owner or successor arising from a Covered Equity Sale or Covered Merger has a separate PPP loan, then, following the consummation of the transaction:

1. in the case of a Covered Equity Purchase, 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
2. in the case of a Covered 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.”

Within five business days of completion of the Covered Equity Sale or Covered Merger, the PPP lender must notify the appropriate SBA Loan Servicing Center of the following:

1. the identity of the new owner(s) of the common stock or other ownership interest;
2. the ownership percentage of each new owner;
3. the tax identification number(s) for any owner(s) holding 20% or more of the equity in the business; and
4. if an escrow account is required, the location of, and the amount of funds in, the escrow account under the control of the PPP lender.

The Notice also states that a PPP borrower remains responsible for all PPP loan obligations and compliance requirements after any Covered Change of Ownership.

Conclusion

PPP borrowers and lenders engaged in or considering an M&A transaction need to review the Notice and take its procedures and requirements into consideration when planning and structuring the anticipated transaction. Lewis Rice will continue to monitor these developments and provide updates as needed. If you would like to sign-up to receive client alerts via email, you can do so here.

Our attorneys are closely monitoring these developments as they occur and will make regular updates to our COVID-19 Resource Center. If you have any questions about the implications and disruptions of COVID-19 on your business, please reach out to one of the authors above or another member of the Task Force.