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SBA Releases Long-Awaited Guidance on M&A Rules for Paycheck Protection Program Borrowers

    Client Alerts
  • October 15, 2020

The Small Business Administration (SBA) recently released a procedural notice concerning when a borrower of a Paycheck Protection Program (PPP) loan may forgo SBA approval in connection with a merger or acquisition. The notice clarifies previous uncertainty regarding when a PPP borrower may be required to obtain SBA approval.

As discussed more below, in order to forgo SBA approval in connection with a “change of ownership” transaction, a PPP borrower must: (1) provide proper notice to their PPP lender and receive the lender’s approval and (2) place the principal amount of the PPP funds into an escrow account in accordance with certain SBA restrictions.

What Constitutes a “Change of Ownership”?

SBA guidance for its 7(a) loan program (on which the PPP is based) provided that a change of ownership of a borrower within 12 months of a loan being issued is prohibited unless the lender obtains the SBA’s prior written approval. However, it was not clear what transactions would constitute a change of ownership. For example, there was doubt whether a sale of a minority stake of a borrower’s equity or a sale of its assets would constitute a change of ownership (although the SBA had indicated informally that it would view a sale of all or substantially all of a borrower’s assets as a change of ownership). It was also not clear if these rules would apply to the PPP, which, despite technically being a part of the 7(a) loan program, has substantial differences. The new notice clarifies this by specifically addressing the PPP and defining a change of ownership based on certain thresholds, as described below:

1.  Equity Sale or Transfer. The sale or transfer, whether in one or more transactions, of 20% or more of the equity of the PPP borrower will constitute a change of ownership. This also includes a transfer or sale to an affiliate or an existing owner of the borrower.

In determining whether the 20% threshold is met, the SBA will aggregate only those equity sales and transfers that occurred since the date of the approval of the borrower’s PPP loan.

2. Asset Sales. The sale or transfer, whether in one or more transactions, of 50% or more of a borrower’s assets (measured by fair market value) will constitute a change of ownership. 

3. Merger. The notice states that a change of ownership occurs when a PPP borrower “merges with or into another entity.” This language indicates that a change of ownership will be deemed to have occurred even if the PPP borrower is the surviving entity of the merger. 

Additional Requirements to Avoid SBA Approval in Connection with a Change of Ownership

The notice explicitly states 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 lender with a copy of the proposed agreement. This is notable given that PPP lenders were not required to utilize the SBA’s standard form of promissory note for the PPP. While the SBA’s standard form of promissory note explicitly requires the lender’s consent to certain changes of ownership, some lenders did not include such language in their own form of note. Even if a borrower’s PPP note does not require prior written notice to or consent of the lender in connection with a change of ownership, given the uncertainty around many of the rules of the PPP, such borrowers are strongly advised to seek lender approval to comply with this notice and not jeopardize potential forgiveness.

If any amount of the PPP loan is still outstanding at the time the transaction closes, the PPP lender may approve the change of ownership transaction without SBA approval only if certain conditions are met. First, no matter the structure of the change of ownership, whether via merger or the sale of more than 50% of the borrower’s equity or 50% or more of its assets, the PPP borrower must complete a forgiveness application reflecting its use of all of the PPP loan proceeds and submit it to the PPP lender with any other required supporting documentation. Secondly, the borrower must establish an interest bearing escrow account with funds equal to the outstanding balance of the PPP loan, and the account must be controlled by the PPP lender. The escrow agreement must provide that after the PPP loan’s forgiveness process is complete the escrow funds will be disbursed first to repay any remaining PPP loan balance plus interest.

The requirement that the escrow account be established with the PPP lender is likely not an issue for larger lenders that often serve as escrow agents; however, this may pose an administrative burden for smaller financial institutions that do not normally provide such services. Therefore, parties to a change of ownership transaction should begin the process of establishing an escrow agreement with the PPP lender early so that it does not hold up the closing process. The parties to the transaction will also need to pay close attention to and negotiate how the funds placed into escrow will affect the purchase price.

Notably, despite defining a change of ownership to include the sale of 20% or more of the equity of a PPP borrower, no consent of the SBA or pre-closing notification to the SBA is required if the PPP borrower is selling 50% or less of its equity, nor is any escrow agreement required. However, notwithstanding the terms in the promissory note, the consent of the lender should be obtained. Given that this disparate treatment for varying levels of equity sales is not explained further by the SBA, to be safe the parties to a change of ownership transaction may wish to establish an escrow account if the sale involves more than 20% but less than 50% of the equity of the borrower. In any event, in a transaction involving the purchase of between 20% and 50% of the target’s equity, an acquirer may require such an arrangement to ensure it has adequate recourse if the PPP loan is not forgiven.

Even if the sale of 50% or less of a PPP borrower’s equity does not require a borrower to apply for forgiveness or establish an escrow account under SBA rules, such a sale may violate the terms of the PPP loan documents drafted by the lender and cause a default. Therefore, in addition to the SBA rules governing notice and escrow requirements, the parties must review their loan documents carefully to ensure compliance with the terms of the PPP loan.  

Finally, even if an escrow agreement or pre-closing notification to the SBA is not required, the PPP lender must notify the appropriate SBA loan servicing center of the change of ownership transaction within five business days of the completed change of ownership. When giving this notice, the PPP lender must also provide certain information about the acquirer as well as the location and amount of funds in an escrow account if one was established. While this is technically the lender’s obligation, PPP borrowers should stay in close communication with their lenders to ensure the notice is made on time and avoid any potential issues with the SBA down the road due to the fault of the lender.

What Responsibilities Does the PPP Borrower Maintain After the “Change of Ownership”?

Regardless of a change of ownership, the PPP borrower remains 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 certifications of economic necessity.

3. Obtaining, preparing, and retaining all required PPP forms and supporting documentation as well as providing PPP information to the PPP lender and SBA upon request.

           4. Compliance with all other applicable PPP requirements.

Given such obligations, any potential acquirer of a PPP borrower, especially via an equity purchase or merger, should carefully analyze the borrower’s application for the PPP and its use of funds. If an acquirer does not thoroughly perform due diligence, it may find itself saddled with the liability of a borrower that did not actually qualify for the PPP in the first place or improperly used the funds. Given the potential penalties for false certifications made to the government, including potential triple damages under the False Claims Act (and possibly criminal charges and fines), these liabilities may be severe and should not be overlooked.

We have a team of people at Parker Poe who are tracking all of this constantly. For more information, please contact us or your regular Parker Poe contact. You can also find our other COVID-19 related alerts here.