M&A Deals and PPP Loans: Unexpected Parties in Your Deal

December 15, 2020 Articles

The Payroll Protection Program has been a lifesaver to many businesses this year, but its quick roll out, and many generous features (including potential forgiveness) could tempt a borrower to treat the PPP as something less than a “real loan.” This, potentially, is a big mistake, as in the context of M&A transactions PPP restrictions, and the practical difficulties in working with those restrictions, have the potential to greatly slow or complicate a deal. This problem is acute for struggling businesses, who are likely to have taken PPP loans, and who may be looking to salvage what value they can in a time-sensitive sale. If you need a timely closing, you must treat your PPP lender and the SBA as essential parties to the deal and engage them as early as practicable.

Most PPP borrowers have signed promissory notes which include mergers, consolidations, changes in ownership, or business structure without lender consent as events of default. On October 2, the SBA issued a “Procedural Notice” (Notice) governing changes in ownership of a PPP borrower (or substantially all of the assets of the borrower). The Notice gives PPP lenders leeway to approve described changes of ownership but only provided specific criteria are satisfied and specific steps are taken.

So what should a potential seller or buyer do?

Step One: Determine if a “Change of Ownership” Has Occurred or Will Occur.

A “change of ownership” may occur more easily than you imagine. Such a change occurs if:

  • at least 20% of the borrower's equity is transferred (including to an affiliate),
  • 50% or more of the borrower’s assets (measured by FMV) are transferred or
  • the PPP borrower is merged into or with another entity.

Note especially that all transfers since the borrower received its PPP loan are aggregated for this purpose.

Step Two: Notify the PPP Lender

The borrower must notify the PPP lender in advance of closing a transaction that results in a “change of ownership” and provide copies of “the proposed agreements or other documents which would effectuate the proposed transaction.” The Notice does not specify how far in advance and exactly what documents should be shared. The actual PPP loan documentation may provide guidance and at least one lender suggests at least 10 business days' advance notice.

The next steps depend on whether the PPP loan will be paid off or forgiven, or, if not, whether it involves the transfer of more than 50% of the borrower’s equity or assets:

Alternative for All Change in Control Transactions: Pay off the PPP Loan or Obtain Forgiveness

No approval restrictions exist if prior to closing the PPP loan is paid in full or the forgiveness process has progressed to the point where the SBA has remitted the forgiveness amount to the lender or the borrower has repaid the remaining balance. The borrower may need to proceed under one of the other options below unless it definitively knows that the loan has been paid or forgiven in full. Note that as written, the Notice procedure requires repayment prior to, rather than concurrently with (i.e., repayment using transaction proceeds) closing. As this seems unnecessarily restrictive, we hope and expect that concurrent repayments, perhaps through a short-term escrow established with the PPP lender, will be permitted.

Next Step if Less Than 50% of the Borrower’s Equity or Assets Have or Will Be Transferred

If less than 50% of the PPP borrower’s equity or assets will have been transferred after giving effect to the change in control, the borrower may apply for and the PPP lender may approve the transaction without SBA input. Presumably, the lender would apply its normal commercial standards and conditions in reviewing any request for approval.

Next Step if More Than 50% of the Borrower’s Equity or Assets Have or Will Have Been Transferred

Alternative One: Submit Forgiveness Application and Escrow the PPP Loan Balance and Apply for PPP Lender Approval

A change of control transaction involving the transfer of 50% or more of the assets or equity of the borrower requires PPP lender approval but not that of the SBA if:

  1. the PPP borrower completes and submits a forgiveness application and

  2. an “escrow account” controlled by the PPP lender in the amount of the PPP loan balance.

Although the lender could apply its normal commercial standards and conditions in reviewing any request for approval, that would seem to be a pro forma exercise since the repayment risk is basically eliminated through the escrow. The complications are that the parties to and terms of the escrow are not specified other than that the escrow must be “controlled” by the lender and that the PPP loan must be paid out of the first funds disbursed, to the extent not forgiven.

Alternative Two: Apply for Approval From the SBA (but Only if the Buyer Is Willing to Assume the Borrower’s PPP Obligations)

All other change of ownership transactions require SBA approval and the buyer’s willingness to take on the seller’s PPP loan obligation through operation of law, in the case of an equity transaction or merger, or expressly assuming the obligation, in the case of an asset sale. The Notice specifies the information to be submitted to the SBA and the SBA has 60 days to make its determination.

What if the Borrower Fails to Comply

Whether or not the borrower complies with these procedures, it remains obligated on the PPP loan. The SBA Notice referred to above is directed at PPP lenders, not borrowers, and the consequences to the borrower of failing to follow these procedures are not explicitly stated. However, most PPP loans list change of ownership defaults, so the acceleration of the loan is the most obvious possibility. Lenders have every incentive to enforce the procedures as violations may also lead the SBA to decline to compensate the lender for loan forgiveness or take other enforcement steps against the lender. In the case of an asset sale, it is conceivable that the SBA or lender will argue that the transferred assets remain subject to attachment or that the buyer has implicitly agreed to assume the loan.

Practical Difficulties

Do not expect navigating the change in control process to be smooth, fast, or easy. The procedures outlined in the Notice are relatively new, omit details, or contain ambiguities—and in any event, do not appear intended to guide borrowers. As a result, it is critical that borrowers engage as early as practical with their PPP lender.

Some practical, and time-consuming, hurdles we have experienced are:

Locating the Right Person. Just finding the right person to talk to is the first step. This may not be the borrower’s normal relationship team. Also, loans are often sold on or managed by third party servicers. Not just finding a person, but finding a knowledgeable, cooperative person within the lender’s or loan servicer’s organization can make all of the difference.

Submitting the Right Documents. The Notice requires borrowers to submit “a copy of the proposed agreements or other documents that would effectuate the proposed transaction.” Determining which of the typical, voluminous, M&A document package are relevant and appropriate may require dialog with the PPP lender until customary practices develop. In addition, M&A agreements frequently contain confidentiality clauses that will need to be negotiated to permit sharing those deal documents with the lender or SBA.

When Is a Forgiveness Application Submitted? As described above, submitting a forgiveness application is a condition of approval of many change in control transactions by a PPP lender. As many PPP borrowers can attest, inadvertent mistakes, rejections, requests for modifications, and even errors by the lender or SBA are common forgiveness application problems. As a result, we have known PPP lenders and servicers to take the position that a forgiveness application is not “submitted” for change in control purposes unless it is in final form and accepted by the SBA.

What Is an “Escrow”? Requiring an “escrow” as a condition to PPP lender approval of a change in control transaction is curious, as a simple, segregated account with or controlled by the lender would seem to protect the lender’s and SBA’s interest. In contrast, setting up a true, third-party escrow can be complicated and time-consuming. Escrow companies are not common in many parts of the country and many, if not most, require extensive documentation and “know your customer” and compliance review, all of which takes time.

A Decision to Escrow Transaction Proceeds Is a Decision to Repay the PPP Loan. A borrower selling 50% or more of its assets or equity that is seeking lender, rather than SBA, approval of the transaction, must repay any portion of its loan PPP Loan that has not been forgiven. That repayment is due when the final forgiveness decision is made or the change in control transaction closes, whichever occurs later.

The Takeaway: Anticipate

As can be seen from this discussion the impact of the SBA Notice on borrowers looking to sell substantial parts of in interests in their business and the process PPP lenders will require is in many respects unclear. What is clear is that the lender and SBA are now unavoidable parties to any such proposed transaction. Since the Notice includes a number of time-consuming conditions to the approval, imposes no specific response time on PPP lenders, and gives the SBA up to 60 days to approve a sale, the biggest takeaway is to get this process going sooner, rather than later.

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