The SBA Issues Guidance on Changes of Ownership of PPP Loan Borrowers
Since the start of the Paycheck Protection Program (“PPP”) in April, business lawyers and their clients who received PPP loans, as well as the lenders who made the PPP loans, have been perplexed over how to treat the PPP loan when the borrower undergoes a change of ownership. The Small Business Administration (the “SBA”) has now provided much-needed guidance in a Procedural Notice issued late on the afternoon of Friday, October 2, 2020 (the “Notice”).
PPP loans are issued under what commonly is called the “7(a) program” of the SBA. Loans under the 7(a) program cannot be made to individuals, and the SBA limits the use of 7(a) loan proceeds to purchase all or a portion of the ownership interests in a business. To police these limitations, the SBA requires that a borrower must seek approval of any change of ownership from the lender and the SBA, and failure to receive such approval constitutes a default under the 7(a) loan. In the context of a PPP loan, the promissory note evidencing the PPP loan generally states that a default occurs under the PPP note if the borrower reorganizes, merges, consolidates, or otherwise changes ownership or business structure without the lender’s prior written consent. Upon a default, the borrower would not be able to seek forgiveness for all or any portion of the PPP loan. The promissory note, however, generally does not address whether the SBA approval also is required, or is waived for PPP loans.
We have encountered a number of different ways in which purchasers of a business and lenders have reacted to this issue, including requiring the borrower to repay the entire PPP loan (thus foregoing forgiveness), requiring an escrow of the outstanding loan amount (with or without interest), requiring the borrower to seek forgiveness before closing (with an escrow of the outstanding PPP loan balance), or requiring the purchaser to become an assignee or co-borrower on the PPP loan. Purchasers and PPP lenders clearly have been concerned about their own responsibilities (and possible liabilities), and this has slowed down many purchase transactions. Thus, the SBA’s publication of the Notice is good news for lenders, borrowers, purchasers, and their counsel.
- OBSERVATION: The Notice is not all good news. One significant issue that the Notice does not address is how transactions that closed and took the steps described above prior to October 2, 2020, are impacted by the Notice. The Notice specifically says that it is effective on October 2, 2020, and the SBA generally has not applied new PPP loan guidance retroactively. It thus is possible that the Notice does not affect the closed transactions. Without further guidance, however, this remains an open question.
The Notice allows the PPP lender to unilaterally approve certain changes of ownership that are described in the Notice, as long as the conditions required by the Notice are followed. The Notice begins with a description of what purchase transactions constitute a “change of ownership” and then describes the conditions that lenders, borrowers and purchasers must meet to comply with the Notice. If the transaction does not fall within the definition of “change of ownership” set forth in the Notice, or if there is a “change of ownership” as described in the Notice but the PPP borrower and purchaser do not meet the conditions of the Notice, then prior approval of the purchase transaction must be obtained from the SBA, and the PPP lender may not unilaterally approve the change of ownership. If the SBA’s prior approval is not sought, then the PPP borrower will be in default, and the ability to obtain forgiveness will be lost.
What Constitutes a “Change of Ownership” Under the Notice?
For purposes of the PPP, a “change of ownership” occurs when:
(1) at least twenty percent (20%) of the common stock of or other ownership interests in a PPP borrower (including a publicly traded entity) is sold or otherwise transferred, whether in one or more transactions, including to an affiliate or an existing owner of the entity;
(2) the PPP borrower sells or otherwise transfers at least fifty percent (50%) of its assets (measured by fair market value), whether in one or more transactions; or
(3) a PPP borrower is merged with or into another entity.
- OBSERVATION: The sale or transfer of ownership does not need to be all of the ownership interests in the PPP borrower, nor does the transaction need to be a sale to a third party. Even transfers of ownership interests in estate planning, transfers to existing owners of the PPP borrower or internal restructurings (e.g., setting up a holding company structure) will need the prior approval of either the lender (and compliance with the Notice) or the SBA.
- OBSERVATION: The asset sale also does not need to be to a third-party purchaser. For example, a split-off or similar restructuring of the business of a PPP borrower into multiple entities would trigger the need for prior approval of either the lender (and compliance with the Notice) or the SBA.
- OBSERVATION: A merger in which the PPP borrower is acquired (in whole or in part) would require prior approval of either the lender (and compliance with the Notice) or the SBA, whether the PPP borrower is the surviving entity in the merger or is merged into another entity created by the purchaser. However, if the PPP borrower acquires another entity by merging that entity into the PPP borrower, as long as there is no change in the ownership of the PPP borrower (or there is a change of less than 20%), then the merger would not constitute a “change of ownership” that would trigger the need for prior approval from either the PPP lender or the SBA.
If a “Change of Ownership” Occurs, What Else is Required?
If a change of ownership is contemplated, the PPP borrower must notify its lender in writing of the contemplated transaction. The Notice does not specify when this written notice must be given, but the PPP borrower is required to submit “a copy of the proposed agreements or other documents that would effectuate the proposed transaction.” Although not clear, it appears that submission of a letter of intent would not suffice. On the other hand, it appears that it is not necessary to wait to submit the signed purchase agreement – a reasonably final draft of the purchase agreement should suffice. This means, of course, that the transaction at least would need to be negotiated to the point where the parties are sufficiently comfortable that the definitive document is fairly close to a final agreement to submit it to the lender.
The remaining provisions of the Notice depend upon whether:
(1) the PPP Note has been fully satisfied prior to the closing of the purchase transaction (i.e., either the PPP Note has been repaid in full, or the PPP Note has been forgiven in full or in part by the SBA and the PPP borrower paid any portion that was not forgiven), in which case there is no restriction on the change of ownership (i.e., prior approval is not required); or
(2) the PPP Note has not been fully satisfied at the time the request for approval is made by the PPP borrower, in which case compliance with the Notice will allow for approval by the lender, but the SBA’s approval would not be required.
- OBSERVATION: Although it is helpful to know that no SBA approval is necessary if the PPP loan has been forgiven or repaid, that will not help the PPP borrower in its negotiation with a potential purchaser. This is because the Notice gives the purchaser an incentive to demand that the PPP borrower repay the PPP Note in full (thus forgoing forgiveness) prior to closing of the transaction. Also, given the time lag to obtain forgiveness (as we have described in our prior Alerts, the process is expected to take at least 150 days after the forgiveness application in completed form is uploaded to the lender’s portal, and lenders have been slow to open their portals). Thus, the PPP borrower will need to negotiate strongly with its potential purchaser to allow it at least to comply with the Notice, so that forgiveness will be possible.
If the PPP Note has not been satisfied when the PPP borrower seeks approval for the change of ownership, then the goal should be to follow the conditions of the Notice, and thus need approval from the lender only, and avoid the need to obtain the SBA’s approval (which invariably should save time). Accomplishing this goal depends upon the structure of the proposed transaction.
For a transaction structured as a purchase of equity interests (i.e., purchase of stock or other equity interests or merger), only the lender’s approval is required if either of the following are met:
(1) If the change of equity ownership is of 20% or more but less than 50%, then the lender may approve the change of ownership without seeking SBA approval.
- OBSERVATION: The distinction made between item #1 above and item #2 below is good news, because most equity transactions in which less than a majority of ownership changes hands would not lend themselves easily to the escrow requirements in item #2 below.
(2) For any other change of equity interests or merger, “[t]he PPP borrower [must complete] a forgiveness application reflecting its use of all of the PPP loan proceeds and [submit] it, together with any required supporting documentation, to [its PPP lender], and an interest-bearing escrow account controlled by [its 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.”
- OBSERVATION: It appears that, if the PPP borrower would not qualify for complete forgiveness, then any transfer of 50% or more of equity ownership or merger would not meet the conditions of this Notice, so the SBA’s consent would be required.
- OBSERVATION: Many PPP lenders use designated neutral closing agents to handle the forgiveness application review and processing, and these lenders might want to use these agents for the escrow, as well. However, it is not clear whether the requirement that the escrow account be “controlled” by the PPP lender would preclude this, and instead require the PPP lender to set up a separate interest-bearing escrow account to handle the process.
For a transaction structured as an asset sale, only the lender’s prior approval is required if: “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 [its PPP lender], and an interest-bearing escrow account controlled by [its 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.”
- OBSERVATION: Just as with an equity change of ownership, if the PPP borrower would not qualify for complete forgiveness, then any transfer of 50% or more of its assets would not meet the conditions of this Notice, so the SBA’s consent would be required.
Additional Provisions Applicable to a Change of Ownership
The Notice includes certain requirements that apply when the change of ownership involves a purchase of equity interests (both items #1 and #2 directly above under “purchase of equity interests”) or an asset sale. These provisions are applicable whether only the PPP lender must approve the change of ownership or the SBA’s approval is required:
(1) In an equity change of ownership, “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. In addition, if the new owner(s) use PPP funds for unauthorized purposes, [the] SBA will have recourse against the owner(s) for the unauthorized use.”
(2) In an equity change of ownership, if any of the new owners (or the successor in a merger) has a separate PPP loan, then and in that event, after the closing of a transaction described in item #1 or item #2 directly above: (a) 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 the PPP requirements relating to each PPP loan, and (b) in the case of a merger, the successor is responsible for segregating and delineating PPP funds and expenses and providing documentation to demonstrate compliance with the PPP requirements relating to each PPP loan.
(3) For an equity change of ownership, the PPP Lender must notify the appropriate SBA Loan Servicing Center, within five business days after the closing of the transaction of: (a) the identity of the new owner(s) of the equity interests, (b) the new owner(s)’ ownership percentage(s), (c) the tax identification number(s) of any owner(s) holding 20% or more of the equity in the PPP borrower, and (d) the location of, and the amount of funds in, the escrow account under the control of the PPP lender, if an escrow account was required.
(4) For an asset sale that constitutes a change of ownership, the PPP Lender must notify the appropriate SBA Loan Servicing Center, within five business days after the closing of the transaction, of the location of, and the amount of funds in, the escrow account under the control of the PPP lender.
- OBSERVATION: The foregoing items #3 and #4 are illustrative of what the PPP lender will require, in addition to a copy of the definitive purchase agreement and an escrow agreement acceptable to all parties, to consider whether to approve the change of ownership. Thus, this information should be available to submit to the PPP lender when the written request for approval of the change of ownership is made.
What if the SBA’s Approval of a Change of Ownership is Required?
If a change of ownership does not meet the conditions specified in the Notice, or the PPP borrower will not be able to seek forgiveness for its entire PPP loan amount, then and in either of those events, prior approval from the SBA of the change of ownership will be required. In these situations, the PPP lender may not unilaterally approve the change of ownership.
- OBSERVATION: Many PPP borrowers may find themselves in a “chicken or egg” situation if the proposed transaction is to occur either before the borrower has exhausted all of the PPP loan proceeds or if the borrower might not be able to obtain complete forgiveness (i.e., less than 60% of the loan proceeds are used for payroll costs, there could be a reduction in forgiveness because of losses in FTEs or reductions in salary or wage rates that cannot be rectified before December 31, 2020). It is possible that the borrower may not be in a position at that time to determine whether it will qualify for full forgiveness. Thus, the PPP borrower is faced with a difficult choice – postpone the proposed transaction until the forgiveness situation becomes clear or seek the SBA’s approval.
- OBSERVATION: The issue is not whether the PPP borrower actually will attain full forgiveness, but rather whether it has a reasonable basis for seeking full forgiveness. In other words, if the PPP borrower has a reasonable basis for seeking full forgiveness, then the provisions of the Notice can be utilized, and even if the SBA ultimately determines that full forgiveness is not justified, the escrow funds will be available to satisfy the balance.
To obtain the SBA’s prior approval, the PPP borrower must submit to its PPP lender, and the lender then must submit to the appropriate SBA Loan Servicing Center, the following:
(1) the reason that the PPP borrower cannot fully satisfy the PPP Note or escrow the funds as described in the Notice;
(2) the details of the requested transaction;
(3) a copy of the executed PPP Note;
(4) the letter of intent and the purchase or sale agreement setting forth the responsibilities of the PPP borrower, the seller (if different from the PPP borrower), and the purchaser;
(5) disclosure of whether the purchaser has or purchasers have an existing PPP loan and, if so, the SBA loan number;
(6) a list of all owners of 20% or more of the purchasing entity; and
(7) any other information that the SBA may deem appropriate “for .additional risk mitigation measures as a condition of its approval of the transaction.”
In addition, “SBA approval of any change of ownership involving the sale of [50%] or more of the assets (measured by fair market value) of a PPP borrower will be conditioned on the purchasing entity assuming all of the PPP borrower’s obligations under the PPP loan, including responsibility for compliance with the PPP loan terms.” In this regard, the purchase or sale agreement must specifically provide for the purchaser’s assumption of the PPP borrower’s obligations under the PPP loan, or a separate assumption agreement must be submitted to the SBA.
The Notice provides that the SBA “will review and provide a determination within 60 calendar days of receipt of a complete request.”
- OBSERVATION: Perhaps the obligation to assume the PPP loan and the additional negotiations that will be required to implement the assumption will provide incentives for a purchaser to agree to cooperate to ensure that the terms of the Notice are met, so that only the approval of the PPP lender will be required, and not the approval of the SBA.
Stay tuned for subsequent updates.
If you have any questions regarding how the Notice impacts your potential sale or purchase transaction, please feel free to contact any member of Trenam Law’s COVID-19 Relief Programs Team or your primary Trenam transaction attorney.
 In a footnote, the SBA stated that “[f]or purposes of determining a change of ownership, all sales and other transfers occurring since the date of approval of the PPP loan must be aggregated to determine whether the relevant threshold has been met. For publicly traded 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.”
 In a footnote, the SBA stated that “[i]f the buyer or the seller (or both) has an outstanding PPP loan, and the change of ownership transaction is financed in whole or in part with a 7(a) loan, all SBA Loan Program Requirements, as defined in 13 CFR 120.10, must be met. In addition, if an escrow account is required under the procedures set forth in this Notice, the 7(a) loan that finances the change of ownership cannot be used to finance the escrow account.”
 In a footnote, the SBA stated that “[i]n determining whether a sale or other transfer exceeds this 50% threshold, all sales and other transfers occurring since the date of approval of the PPP loan must be aggregated.”