SBA Issues Much-Anticipated Guidance Regarding Changes of Ownership in PPP Loans

Unforgiven Paycheck Protection Program (PPP) loans have created a great deal of consternation for PPP borrowers looking to engage in merger and acquisition (M&A) transactions, as well as other asset sale, equity and restructuring transactions that could trigger a "change in ownership" (including employee stock ownership plans (ESOPs), estate planning transfers and similar transactions in addition to traditional M&A deals and private equity investments). PPP loans have been lifelines to many businesses, and now the next part of such a success story may involve some form of a change in ownership.

A default typically would arise under most PPP loan documents if one of these types of transactions occurs. For example, the standard U.S. Small Business Administration (SBA) note form from the SBA 7(a) program, which many lenders used for their PPP programs, includes a default if the borrower "reorganizes, merges, consolidates, or otherwise changes ownership or business structure without Lender's prior written consent." However, PPP lenders, many of which had never engaged in SBA lending before the PPP program, have only more recently become aware that the SBA's policies and procedures for servicing 7(a) loans (SOP 50 10 5(K)) not only applied to PPP loans generally but include a requirement that "Lenders may not unilaterally approve any adjustment to or change in the ownership of a Borrower, including a change in percentage of ownership, for 12 months after final disbursement on any loan."

Background and Concerns

Some observers have suggested that changes in ownership of a PPP borrower also bring into question the certification of necessity made by the PPP borrower to obtain the PPP loan, equating to evidence that the PPP funds were used as a bridge to a liquidity transaction for owners or creating indirect increases in purchase price and therefore not truly being used for retaining employees and maintaining wages.

Further, compliance with the PPP rules regarding affiliation has been questioned where even a letter of intent exists between a PPP borrower and third party.

As transaction activity began to start up again, while the forgiveness application process stalled, parties looked to PPP lenders for help, who in turn eventually looked to the SBA. Many expected that consents would not be forthcoming because a change in ownership was evidence of a lack of necessity. Others claimed to have an inside track to obtaining consents, resulting in an effort to forum shop. Finally, the SBA advised that all requests for consent must be placed through the standard 7(a) consent process, but provided no confirmation to exactly what would be approved.

Inconsistent documentation and feedback have plagued program participants to date. Documentation was rarely, if ever, tailored to the exact circumstances of that PPP borrower's ownership structure, so events of default simply referring to a "change in ownership" led to confusion: Did that include any change in ownership, even one share transferring hands to another existing shareholder? The expanded nature of participants in the PPP program created many situations that would have been less likely to arise with traditional SBA program borrowers.

In the meantime, many players in the market have settled on using an escrow for the amount of the PPP loan, which created a plausible explanation to provide to the SBA along the lines of, "We requested consent but understood it would not come in time so we protected all parties' interest, including yours, by placing the full amount of the loan in escrow." However, many have feared that any M&A transaction would jeopardize forgiveness or, worse yet, draw further unwanted attention from the SBA, and as such required repayment of the PPP loans, which otherwise may not have been warranted.

It is therefore of considerable relief for many program participants that the SBA has finally released a Procedural Notice to all SBA employees and PPP lenders that addresses the consent issue for M&A transactions that the market has been struggling with in recent months.

Procedural Notice Overview

As a preliminary matter, the SBA guidance released on Oct. 2, 2020, provides some useful certainty for what constitutes a change of ownership by setting the 20 percent threshold for covered transfers of the common stock or other equity interest (although internal transfers among owners are not exempted) in one or more transactions in the aggregate, which certainly eliminates a number of transactions. It also clarifies that a change of ownership includes sales of 50 percent or more of a businesses' assets and all mergers (which could include intercompany mergers with subsidiaries – i.e., internal restructurings), a result that some stakeholders had hoped to avoid.

Regardless of any change of ownership, the PPP borrower remains responsible for 1) performance of all obligations, 2) the certifications made, including necessity, and 3) compliance with all other applicable PPP requirements. The PPP borrower also remains responsible for obtaining, preparing and retaining all required PPP forms and supporting documentation, as well as providing those forms and supporting documentation to the PPP lender or to the lender servicing the PPP loan, or to SBA upon request. SBA reserves all rights and remedies available under the law in the event of fraud, false statements and/or unauthorized uses of PPP loan proceeds.

If, however, the PPP loan has been paid in full, or if the completed application has been processed and the SBA has already remitted funds to the PPP lender and any remaining balance has been repaid, no SBA consent is required. This will not have utility unless the forgiveness process is satisfied, leaving a second option to avoid the need for SBA consent: the 1) completion of the forgiveness application plus 2) the escrowing of an amount equal to the "outstanding balance" of the PPP loan (almost always the entire amount of the PPP loan) in an interest-bearing account controlled by the PPP lender, which will be problematic in a deal where there is not significant cash exchanging hands (i.e., in ESOP transactions where seller notes are issued or in a case where the buyer's funds are being used to repay other creditors and not available to be escrowed).

If the PPP loan has not been satisfied, a PPP lender may consent to the transaction without SBA approval in a stock deal or merger if it is less than 50 percent in the case of a stock deal or, again, if the PPP forgiveness application is completed along with supporting documentation and the amount of the PPP loan is placed in an interest-bearing escrow account controlled by the PPP lender.

However, in the case of asset sales not subject to the exemptions described above, prior SBA approval is now clearly required, unless the PPP forgiveness application is completed along with supporting documentation and the amount of the PPP loan is placed in an interest-bearing escrow account controlled by the PPP lender.

In all of these other instances, where SBA consent is required, the PPP lender must submit an extensive set of deliveries:

1. the reason the PPP borrower can't satisfy the PPP loan or escrow funds
2. the details of the transaction
3. a copy of the PPP note
4. the letter of intent and purchase agreement
5. disclosure of any PPP loan of the buyer (and loan number)
6. list of all owners of 20 percent or more of the equity of the buyer

Once received by the SBA, the SBA has established a 60-day review period for consent requests, which might seem like an eternity in today's fast-paced deal world. Nevertheless, at least now there is a road map for when consent is required and how to structure deals appropriately, which is a huge improvement from the past few months.

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