Earlier this month, the U.S. Small Business Administration (the “SBA”) issued Procedural Notice Control No. 5000-20057 (the “Guidelines”), providing guidance with respect to M&A transactions involving entities with outstanding Paycheck Protection Program (“PPP”) facilities. This Alert summarizes the Guidelines as they relate to change of control and M&A transactions, specifically with respect to diligence review, transaction timing and SBA consent requirements.
“Change of Ownership”
For purposes of the PPP, a “change of ownership” is deemed to have occurred upon (i) the sale, transfer or other conveyance of (A) at least 20% of the common stock or other equity interests of a PPP borrower (including publicly traded companies), including to any affiliate or existing owner of such PPP borrower, or (B) at least 50% of the assets of a PPP borrower (calculated in terms of fair market value), in each case whether in one or a series of transactions, or (ii) the merger of any PPP borrower with or into another entity. In determining whether a PPP borrower satisfies the foregoing thresholds, the SBA will aggregate all sales and other transfers occurring since the initial date of approval of the PPP facility.
Regardless of the consummation of any change of ownership transaction, the PPP borrower will remain fully responsible for its obligations under its existing PPP facility, including all certifications made in connection with such borrower’s initial loan application. The Guidelines specifically reference compliance with the economic necessity certification as an example. Further, PPP borrowers remain responsible for obtaining, preparing and retaining all PPP documentation relevant to the loan, as required by its applicable PPP lender, and providing the same to the SBA upon request.
Prior to the closing of any change of ownership transaction, a PPP borrower must notify its PPP lender in writing of the proposed transaction, which notice must provide a copy of all proposed documentation contemplated to effect the transaction.
Negotiations regarding transaction timing and structure must necessarily contemplate required SBA approvals upon a change of ownership. The Guidelines address the following circumstances under which prior SBA consent may or may not be required in addition to the prior written consent of the target company’s PPP lender.
- Generally, there are no restrictions on a change of ownership transaction if, prior to closing, (i) the PPP loan has been paid and satisfied in full, or (ii) the PPP borrower has completed the loan forgiveness process and (A) the SBA has remitted funds to PPP lender in full satisfaction of the loan, or (B) the PPP borrower has repaid the outstanding balance of the PPP loan in its entirety.
- SBA consent is not required under the following circumstances:
- In the event that the change of ownership is structured as a sale or transfer of common stock or equity interests or as a merger, the PPP borrower may consummate such transaction without prior approval of the SBA if (i) the sale or transfer is of 50% or less of the common stock or equity interests of the PPP borrower, or (ii) the PPP borrower submits a forgiveness application indicating its use of all PPP proceeds, together with any required supporting documentation, to PPP lender, and a lender-controlled, interest-bearing escrow account is established with funds equal to the outstanding balance of the PPP loan. Upon completion of the forgiveness process, the escrow amount must be disbursed first to satisfy the outstanding PPP loan balance plus interest.
- In the event that the change of ownership is structured as an asset sale, the PPP borrower may consummate such transaction without prior approval of the SBA if the PPP borrower submits a forgiveness application indicating its use of all PPP proceeds, together with any required supporting documentation, to PPP lender, and a lender-controlled, interest-bearing escrow account is established with funds equal to the outstanding balance of the PPP loan. Upon completion of the forgiveness process, the escrow amount must be disbursed first to satisfy the outstanding PPP loan balance plus interest. In this case, the PPP lender must notify the appropriate SBA Loan Servicing Center of the location of, and the amount of funds in, the escrow account within 5 business days of consummation of the transaction.
- In the event that a change of ownership transaction fails to satisfy any of the foregoing conditions, the parties will be required to obtain SBA consent in connection with the same (and the PPP lender may not unilaterally approve the transaction). In such case, the PPP lender is responsible for submission of an approval request to the appropriate SBA Loan Servicing Center, setting forth in detail:
- The reason that PPP borrower is unable to fully satisfy the PPP loan or escrow funds as described above;
- Details of the proposed transaction;
- A copy of the PPP Note;
- Any letter of intent and the purchase agreement setting forth the obligations of the PPP borrower, seller (if an entity other than the PPP borrower), and buyer;
- Information regarding any existing PPP loan obtained by buyer (if any); and
- A list of all owners of 20% or more of the equity of the acquiring entity.
The SBA will review and provide a determination within 60 calendar days of receipt of a complete consent request, which will inevitably factor into the initial determination by the parties of transaction timing and target closing.
In addition to the threshold consideration as to whether a change of ownership transaction requires prior authorization by the SBA, the Guidelines highlight several additional restrictions and obligations to be considered when structuring an M&A transaction and allocating risk under the definitive documents. Below is a high-level summary of those considerations:
- SBA may require, in its sole discretion, additional risk mitigation measures as a condition of its approval of any change of ownership transaction.
- SBA approval of the sale of 50% or more of the assets of any PPP borrower will be expressly conditioned on the assumption by the acquiring entity of PPP borrower’s obligations under the PPP loan (including responsibility for continued compliance). The purchase agreement drafted in connection with the transaction must address such assignment and assumption, or a separate assumption agreement must be submitted to the SBA.
- For all sales of common stock or equity interests or mergers, whether or not SBA approval is required, the PPP borrower or successor by merger, as applicable, will remain subject to all obligations under the PPP loan. In addition, the SBA will have full recourse against the new owners in the event they use the PPP funds for any unauthorized purpose.
- In the event that any new owner or successor in interest by merger, as applicable, has obtained its own PPP facility, then, upon consummation of any change of ownership transaction, the PPP borrower and new owner or successor, as applicable, are responsible for segregating and delineating PPP funds and expenses, and providing documentation to demonstrate compliance with PPP requirements under both PPP loans.
- The PPP lender must notify the applicable SBA Loan Servicing Center within 5 business days of consummation of the transaction of the identity of the new equity holders, such new holders ownership percentage and the tax ID number for any owner holding 20% or more of the aggregate equity in the business.
As we continue to see an uptick in M&A deal flow, it is critical that potential buyers consider the impact of requirements set forth in target’s PPP loan documentation as well as SBA change of ownership requirements as set forth in the Guidelines. The existence of outstanding PPP loans on both the buy-side and sell-side will have implications on transaction structure and timing, due diligence and the representations, warranties, covenants and indemnities contained in the purchase agreement and transaction documents entered into among the parties. Our attorneys are available to guide you and answer any questions regarding the Guidelines and related M&A transaction considerations.
As the law continues to evolve on these matters, please note that this article is current as of date and time of publication and may not reflect subsequent developments. The content and interpretation of the issues addressed herein is subject to change. Cole Schotz P.C. disclaims any and all liability with respect to actions taken or not taken based on any or all of the contents of this publication to the fullest extent permitted by law. This is for general informational purposes and does not constitute legal advice or create an attorney-client relationship. Do not act or refrain from acting upon the information contained in this publication without obtaining legal, financial and tax advice. For further information, please do not hesitate to reach out to your firm contact or to any of the attorneys listed in this publication.