On Friday, October 2, 2020, the Small Business Administration (SBA) issued a Procedural Notice (the “Notice”) explaining required procedures when an entity that has received a Paycheck Protection Program loan (a “PPP Borrower”) experiences a change in ownership. In particular, the Notice sets forth the circumstances in which SBA consent is required prior to a change in ownership and the steps PPP Borrowers and lenders must take to avoid defaulting on PPP loans as a result of a change in ownership.
Change in Ownership
The Notice defines a “change of ownership” as the occurrence of any of the events described below:
- At least 20 percent 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 PPP Borrower.
- A PPP Borrower sells or otherwise transfers at least 50 percent of its assets (measured by fair market value), whether in one or more transactions.
- A PPP Borrower is merged with or into another entity.
Note that a PPP Borrower must aggregate all sales and other transfers occurring since the date of approval of the PPP loan to determine whether the 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 percent must be aggregated.
There are no restrictions on a change of ownership if, prior to the closing of the applicable transaction, either (i) the PPP loan has been repaid in full or (ii) forgiveness of the PPP loan has been determined, the SBA has remitted funds to the PPP lender under its guaranty, and the PPP Borrower has repaid any unforgiven balance.
For all other change of ownership transactions, regardless of whether SBA consent is required, a PPP Borrower is required to provide prior notice to the PPP lender in writing of the contemplated transaction and provide the PPP lender with a copy of the proposed agreements or other documents that would effectuate the proposed change of ownership transaction.
SBA Consent Not Required; PPP Lender Approval
SBA consent is not required for (i.e., the PPP lender may unilaterally approve) the following change of ownership transactions:
- A sale or transfer of stock or other ownership interest or merger in which: (a) 50 percent or less of the PPP Borrower’s stock / ownership is sold or transferred; or (b) the PPP Borrower completes a loan forgiveness application reflecting its use of all loan proceeds and submits it to the PPP lender and deposits the outstanding balance of the PPP loan in an interest-bearing escrow account controlled by the PPP lender.
- A sale of 50 percent or more of a PPP Borrower’s assets in which the PPP Borrower completes a loan forgiveness application reflecting its use of all loan proceeds and submits it to the PPP lender and deposits the outstanding balance of the PPP loan in an interest-bearing escrow account controlled by the PPP lender.
For transactions that involve a sale of all or substantially all the assets of, or ownership interests in, a PPP Borrower: (a) the parties may not proceed to closing without the approval of the PPP lender (which it is now expressly empowered to give by virtue of the Notice), (b) the parties must ensure that the PPP Borrower’s loan forgiveness application is properly submitted prior to closing, and (c) the parties must establish and fund an escrow account controlled by the PPP lender at closing. While this does not significantly change a PPP Borrower’s obligations with respect to its PPP loan, buyers now have potential risk and should adhere to the Notice’s requirements to minimize any assumption of liability. Also, the Notice does not prescribe a time period within which a PPP lender must make its determination.
SBA Consent Required
For any change of ownership transaction not described above, a PPP Borrower must obtain SBA consent prior to closing. To obtain the SBA’s consent, the PPP lender must submit to the SBA a request for approval including: (i) the reason that the PPP Borrower cannot fully satisfy the PPP loan prior to closing or escrow funds as described above, (ii) the details of the transaction, (iii) a copy of the PPP note, (iv) copies of any letter of intent and the purchase or sale agreement setting forth the responsibilities of the PPP Borrower, seller (if different from the PPP Borrower), and buyer, (v) disclosure of whether the buyer has an existing PPP loan and, if so, the SBA loan number and (vi) a list of all 20 percent or greater owners of the buyer. The SBA will review the documents submitted by the PPP lender and provide a decision within 60 days of receipt of a complete request. If applicable, this process could place significant conditionality on a closing.
The SBA may condition its consent on additional risk mitigation measures. Additionally, SBA consent to any change of ownership involving the sale of 50 percent or more of a PPP Borrower’s assets (measured by fair market value) will be conditioned on the buyer assuming the PPP loan and responsibility for compliance with its terms. In such cases, the purchase or sale agreement must include appropriate language regarding the assumption of the PPP Borrower’s obligations under the PPP loan by the buyer, or a separate assumption agreement must be submitted to the SBA.
Despite the occurrence of a change of ownership, a PPP Borrower remains responsible for: (1) continued performance of all obligations under the PPP loan; (2) certifications made under the PPP loan application, including the certification of economic necessity; and (3) continued compliance with all other PPP loan requirements. The PPP Borrower will also remain responsible for obtaining, preparing, and retaining all required forms and documentation and providing these forms and documents to the PPP lender, servicer, or SBA upon request.
A PPP Borrower will remain liable for any unauthorized uses of PPP loan proceeds by the new owner or successor following a change in ownership transaction. If the new owner or successor also has a PPP loan, each PPP loan must be segregated and properly allocated among the two borrowers.
While the Notice provides some sorely needed guidance for parties in the context of M&A transactions, it remains unclear as to whether transactions that closed prior to the date of the Notice could be subject to its requirements. As indicated above, we think this likely has potential impact on buyers, irrespective of how they contract for a PPP Borrower’s liability within the definitive agreements. Varnum will continue to monitor this issue as well as any additional guidance issued by the SBA.